Category Archives: Current Markets

Crude Oil and the World Market

Crude Oil and the World Market

 

May has been an interesting month in the crude oil futures market. The crude oil market has sold off more than 25% of its value in the last month. It has gone from trading at over $90 per barrel down to $67 per barrel. The selloff has been based on two primary concerns; First, the continuing slowdown in Europe and secondly, the growing strength of the U.S. Dollar. However, commercial traders are betting that these concerns will be more than offset by continued growth in developing countries and declining domestic production through the politicizing of off shore drilling.

The European Union is going to face continued economic pressure as they deal with the after effects of their own credit bubble. We have written extensively about the troubles in Greece, “Pandora’s Grecian Riddle.” We also suggested that Greece would merely be the first European Union to succumb to the hubris of its own administration and that this would quickly be followed by Spain and Italy. An appropriate parallel is to the individual financial giants here in the U.S. as the government decided who lived and who died. For the purpose of understanding the selloff on crude oil, the important takeaway is one of simple human basic need. The countries in the European Union will experience a manufacturing slowdown. However, they will continue to cook, heat their homes, drive their cars and maintain the base needs of fully developed countries.

The growing strength of the U.S. Dollar has made crude oil cheaper because crude oil is traded on U.S. exchanges and priced in U.S. Dollars. Therefore, as the Dollar rallies, so does our purchasing power. However, since the beginning of May, the Dollar has only rallied about 7%. Obviously, this does not account for crude oil’s 25% decline. Of course, astute readers will recall that in February, when the Dollar rally began, crude oil experienced a 14% drop on a 4% rally in the Dollar. This created a selloff down to $70 per barrel before rallying back to $90. Therefore, the correlation remains within normal boundaries.

The growing case for crude oil bargain hunting at these levels can be made through the case of the developing middle class of very large Asian populations. The demographic argument states, broadly, that money follows population growth and education. Psychologically speaking, people first seek to meet their basic needs of food, shelter and clothing. As these needs are met and existence transitions to living, the population wants better food, nicer clothes, DVD players and cars. These populations will develop their economies from the inside. However, their production facilities will require more raw materials to produce an equal amount of goods than the efficient production facilities in developed countries. Their higher rate of consumption will help to support global demand for fossil fuels.

British Petroleum’s recent disaster in the Gulf will further constrict domestic supplies going forward. No one can argue the magnitude of this disaster. Many more Americans will truly see and feel the impact of this environmental calamity because it happened in the Gulf, rather than in Alaska, like the Exxon Valdez. The emotional impact will rally voters to back Obama’s moratorium on offshore drilling and put further National Park drilling in jeopardy.

Finally, let’s look at the market internals themselves. Commercial traders, via the Commitment of Traders Report have continued to buy the market the entire way down through this decline. This means that the people who live and die by this market feel that these are value prices. Their trading programs are not based on swing trading. Their trading methodologies are based on fundamental factors like supply and demand and currency exchange rates. They also incorporate seasonal usage data into their trading algorithms, which suggests the crude oil market should continue to see increased demand through the end of August.

The sum conclusion of this selloff in crude oil is that it should be viewed as a buying opportunity for the long term. This is one of the situations where efficient portfolio analysis would suggest that allocating a portion of an overall portfolio to inflation sensitive, fundamental goods would not only put your trading in line with the commercial hedgers, but also provide some overall portfolio diversification.

This blog is published by Andy Waldock. Andy Waldock is a trader, analyst, broker and asset manager. Therefore, Andy Waldock may have positions for himself, his family, or, his clients in any market discussed. The blog is meant for educational purposes and to develop a dialogue among those with an interest in the commodity markets. The commodity markets employ a high degree of leverage and may not be suitable for all investors. There is substantial risk in investing in futures.

A Quick Memory Test

Q:Last week, crude oil fell $20 per barrel. According to the Department of Energy’s “First Purchase Price,” when was the last time crude traded at $20 per barrel??????

A:March of 2002! I certainly thought it was pre-911.

Click on the link for the full DOE price series.

8-3 doe.asp.xls

 

 

Mother Nature’s Resilience

The current corn crop appears to have materially overcome the delays of a wet spring. April’s plantings were 30% behind normal. The picture became grimmer when May’s plantings were as much as 50% behind normal. This led to serious concerns as yield has been directly correlated to planting date, with yield falling consistently with date planted after May 1st. However, through the modern technology of GPS, tractors were able plant through the night as the weather allowed. This led to being fully planted by USDA Grain Report June’s acreage report. Now, corn has been in the ground and had a chance to grow with some periods of sunshine and good ground water tables. Mother Nature has done her thing as corn across the country has been racing to catch up. Currently, even with all of the delays in planting, corn rated in “good to excellent” condition is ahead of the five year average!

Given the drastic change in perspective from a dire spring to excellent condition as we head into the pollination period, it’s not surprising that the market has sold off as dramatically as it has. However, it’s important to keep a global perspective on the corn market. Even if corn is on the pace of 155 bu/acre yields, at 87.5 million acres planted this will still leave us with a stocks to usage ratio at or, near all time lows. This is also consistent with the International Grain Council’s expectation of global ending stocks being 24+ mmt lower than last year. Furthermore, with the Dollar expected to decline through the end of the year, we will continue to see strong export demand, especially in China as Hog feed usage continues to climb. We will be able to track China’s purchases through the Commitment of Traders Reports.Ultimately, as we have fallen to test the April –  June congestion between $5.70 and $6.20, traders and hedgers should prepare to use this as a longer term buying opportunity.

US Dollar Index

Here is one for the statistical folks out there. It is a very rare combination to have a large speculative long position, which can be checked in the Commitment of Traders Reports in the face of large one day gains in both oil and gold. In fact, it has happened only 4 times. Three out of four occurrences saw the Dollar decline by an average of 2.1% relative to yesterday’s close 72.79. The trough of this decline comes approximately 26 days after the event. Therefore, we can look for a Dollar objective of 71.34 around August 8th.This fits pretty well with the last Dollar trade posted….expecting a test of the 71.00 lows.

 

Corn Crop Deterioration

The fundamentals f the corn market continue to point towards higher and higher prices. I understand that many people had a hard time forcing themselves to buy new crop corn $6 a bushel. Unfortunately, $7 is here and $7.50 is not far off. The corn market is experiencing a “perfet storm.” The short list of contributing factors are:1) Tight ending stocks leave us very dependent on this year’s crop.2) Increasing global (Asian) demand for red meat funnels more corn to feed.3) Declining Dollar increases global demand for our exports.4) The late start to this year’s crop will have a material effect on yields.5) Growing position of index trader positions in the Commitment of Traders Report.

The following article on Bloomberg goes into more detail without having to source each piece of the puzzle individually. If anyone wants more detail than it provides, please contact me directly.

Corn Deluged by Iowa, Illinois Rain Cuts Yields, Boosts Prices

By Jeff Wilson

Enlarge Image/Details

June 10 (Bloomberg) — Rainstorms sweeping the biggest corn states in the U.S. are damaging a crop that’s already failing to keep pace with global demand for food, fuel and cattle feed.

Farms in Iowa were drenched with 5.78 inches of rain last month, or 37 percent more than normal, according to :S:d1″>Harry Hillaker, the climatologist for the biggest corn-growing state. The 22.23 inches that fell on Illinois from January through May was 45 percent above normal and the third-wettest on record, according to data compiled by the state.

Corn rose to a record $6.73 a bushel yesterday in Chicago, extending this year’s gain to 44 percent. Yields in the U.S. may fall 10 percent short of government forecasts, the biggest drop in 13 years, and send prices up another 34 percent as storms delay planting, stunt growth and leech fertilizer from the soil, said :S:d1″>Terry Jones, who farms more than 6,000 acres near Williamsburg, Iowa.

“It’s already a disaster,” said :S:d1″>Palle Pedersen, an agronomist at Iowa State University in Ames.

About 60 percent of the crop in the U.S., the world’s largest grower and exporter, was in good or excellent condition as of June 8, down from 63 percent the previous week, the Department of Agriculture said yesterday in a report. A year earlier, 77 percent got the highest rating. Iowa, Illinois, Nebraska, Minnesota and Indiana, the five top-producing states, reported declines.

`Midwest Flooding’

Check USDA Grain Reports

Rainfall across the Midwest was as much as four times normal over the past 60 days, according to National Weather Service data. In some places, storms dumped 15 inches more than average, the data show. The increase is equal to the typical rainfall some fields receive in a year, said :S:d1″>Roger Elmore, who is also an agronomist at Iowa State.

“The Midwest flooding is widespread and that has already hurt the crop,” delaying development and drowning some immature plants, said Jones, who is vice president of Russell Consulting Group in Panora, Iowa. “We could see national yields fall at least 10 percent, even with normal growing conditions the remainder of the year.”

Spring planting was delayed by rain and unusually cool weather that left fields too muddy for tractors and limited growth. U.S. corn planting was 51 percent completed by May 11, less than 71 percent the previous year, USDA data show.

The yield potential for corn drops unless plants emerge from the ground before the end of May in the Midwest, according to a University of Illinois study. The USDA estimated 78 percent had emerged as of June 1, compared with 92 percent a year earlier. To produce the best yields, corn needs to pollinate before the arrival of summer weather.

$8 a Bushel

“The crop is in serious trouble,” said :S:d1″>Jim Stephens, president of Farmers National Commodities Inc. in Omaha, Nebraska, who helps manage more than 3,600 farms across the Midwest. He said corn will top $8 a bushel this year.

The weather is endangering a U.S. crop already expected by the USDA to decline from last year’s record harvest after farmers planted 8.1 percent fewer acres. Global inventories may fall to the lowest levels in 24 years by Aug. 31, the USDA said.

U.S. farmers shifted to soybeans and wheat because the costs of corn is high relative to other crops. The USDA will update its yield and inventory estimates today in Washington and its estimate of U.S. planted acreage on June 30.

Demand for corn to feed livestock jumped 24 percent in the past decade as economic growth boosted incomes and meat consumption in developing countries. The prices of corn, soybeans, rice and wheat surged to recor
ds this year as food demand outpaced production. In the U.S., the cost of corn was increased by government subsidies and mandates for ethanol.

Rising Prices

In the top eight producing states, which grew 75 percent of last year’s crop, there is more acreage at risk than in 1993, when yields plunged 23 percent, said :S:d1″>Chip Flory, editor of the Professional Farmers of American advisory in Cedar Falls, Iowa.

Corn futures for July delivery rose 6.5 cents, or 1 percent, to $6.5725 a bushel yesterday on the Chicago Board of Trade, after touching a record high for a third straight session.

The saturation of soil moisture is in the 98th percentile of the highest levels in the past 40 years from South Dakota to Ohio, according to government data, increasing the risk of reduced yields from the loss of nitrogen fertilizer, Iowa State University’s Elmore said. The saturated soils are depleting fertilizer at a rate of as much as 4 percent a day, he said.

Farmers were expected to produce about 153.9 bushels an acre on average, up from 151.1 bushels last year, the USDA said May 9. Instead, yields probably will drop below 139 bushels and may fall even more, said Jones, the Iowa farmer.

To contact the reporter on this story: :S:d1″>Jeff Wilsonjwilson29@bloomberg.net

 

Defending the $ and Popping the Bubble

Yesterday, Bernanke stated that a weak Dollar was not in America’s best interest. Typically, this statement would be argued against based on a weak Dollar’s contribution to exports helping to grow a weakened domestic economy. Bernanke’s point, I think, is that inflation is a bigger worry than recession. Dollar based commodities, primarily grains and energy are having a greater negative impact on our economy than can be offset through higher exports. Inflation in these primary goods is acting as a tax on the American consumer. Right now, the economy cannot create enough high quality jobs fast enough to offset the economic pain that is felt at the gas pump and grocery store.Further more, Bernanke also stated that he will work with Secretary Paulson to defend the Dollar’s decline. This is important because the Federal Reserve and the Treasury are separate entities. It is a big deal that Bernanke used language such as, “In collaboration with our colleagues at the Treasury…” as well as, “…ensuring that the Dollar remains a strong and stable currency.”

These are strong words from the chairman of the Federal Reserve. The perfect storm could be brewing……strengthening Dollar combined with regulatory action, via the CFTC closing the “swap loophole” on Commodity Index Traders could bring liquidation across the commodity spectrum. It will be important to check the Commitment of Traders Reports for position changes.

Competitive goods at the margin

As petroleum prices climb, alternative energy sources become more useful. So it is with biodiesel and soybeans. Look at the correlation during yesterday’s sell off and today’s rally.

Now, look at the 25 day correlation chart between the two markets.

Crude Fundamentals Remain Negative

The underpinnings of the Crude Oil market do not justify the current market prices.

1) Crude made new all time highs Friday….on declining open interest, which peaked last July.2) Distant delivery for Crude isn’t charging the storage and insurance premiums it should in a healthy bull market.3) Using NYSE prices, oil stocks are pricing it at $75 per barrel. 4) According to Business Week, the major players have done little to increase capital spending….even at these prices.