The Overnight Report: Oil Finally Begins To Bite

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By Greg Peel

The Dow fell 104 points or 0.8%, while the S&P fell 0.8% and the Nasdaq had a change of fortune falling 1.3%.

While earnings were again focus, the real point of weakness on Wall Street came when oil hit US$120/bbl for the first time. It slipped slightly to settle the day, and close out the May delivery contract, at US$119.50/bbl – up US$2.02.

The renewed confidence on Wall Street post Bear Stearns, enough to have send the Dow up some 850 points, has come in spite of the rapidly rising oil price. There are few sellers left in the market, and there are plenty of buyers sitting in cash waiting for the signal to dive in. The sellers feel the Bear Stearns saga indicated a point beyond which the market could no longer fall, thus offering little downside, while most buyers are content to wait in cash – despite negative real interest rates – to see how the recession plays out. April volumes have been decidedly low compared to previous months. There is no conviction either way. The Dow was down 170 points at its nadir last night.

If timid buyers needed any reason to remain reluctant, it is the oil price, which has risen 26% in 2008 alone. One by one economies around the globe are announcing soaring wholesale inflation numbers which have translated into strong, but lower retail inflation numbers. Profit margins are shot. If one needed any indication, it would come from the first quarter result released last night by UAL – the owner of United Airlines. While clearly oil is a vital input to airline cost, more so than your average business, United’s poor result and subsequent 37% collapse in share price was unprecedented.

The rise in oil came as once again the US dollar slid to a record low against the euro, which traded to US$1.6017 before falling back to US$1.5985 by the close. But trying to untangle the reasons behind the moves is only an exercise in twisted logic. Oil traders say they bought last night on the falling dollar. Currency traders said they sold the dollar on rising oil. Providing stimulus to the mix was one ECB committee member who suggested the central bank would do “whatever it takes” to get European inflation back to 2%. This means the ECB will not cut rates and might even raise them, which will push the US dollar lower and oil higher – oil being a large part of the inflation equation in the first place.

See the problem?

Just how much of the oil price is fluff? Nevertheless, we currently have a step-up in terrorist-related supply disruption in Nigeria, OPEC has again refused pleas to increase output, and a US government report suggests Gulf of Mexico production fell to its lowest level last week since Katrina. On the other side of the equation, China reported higher than expected demand last month. It’s very hard to see a reason why the oil price can meaningfully fall right now.

In the meantime, Canada last night cut its interest rate by 50 basis points to 3%. The Bank of Canada cited expectation of a “deeper and more protracted slowdown in the US economy” than previously expected. It lowered Canada’s 2008 GDP growth expectations from 1.8% to 1.4%. Canada is inexorably tied to the US – its GDP 25% reliant on US trade. But goods travel both ways, and the surging Canadian dollar has meant inflation has been kept at a globally amazing 1.4%. No wonder the BoC can feel comfortable in cutting rates. Jean-Claude Trichet must be green with envy.

A new record low in the US dollar, and the inflationary effect of a surging oil price must, of course, translate into a surge in the gold price. At least it would, were there anyone keen to buy gold at the moment. The alternative currency added a mere US80c to US$916.90/oz and appears to be hanging by a gossamer thread.

The Aussie crept up another US0.3c to US$0.9450.

Base metals took their lead from the weak US dollar, and from the strike in Chile entering its seventh day with no end in sight. Tin jumped 4.4% by day’s end to a new record high. Aluminium rose close to 1%, while copper and remaining friends rose 1-2%.

Coming back to the US stock market, it was another mixed day for earnings. Dow components AT&T and DuPont both registered results in line with expectation, but DuPont shares fell 4% on weak second quarter guidance. Growth in earnings offshore is being offset by the slump in the US, management suggested. McDonalds beat the Street but registered declining same-store sales for March, which put a dampener on the result. If Americans aren’t eating McDonalds what on earth are they eating? Fruit and vegetables? Surely not.

All up, the tone of earnings results to date has been one of more downside disappointment than upside surprise. Lost in the mix last night were another round of housing data. The National Association of Realtors announced sales of existing homes fell 2% in March, to be down 19.3% for the year and off 33% from the 2005 peak. Market watchers have been hoping bargain prices would encourage investment buyers into the market but no – inventories climbed 1% to 4 million, or ten months supply. Of that number, 18% are either in foreclosure or for sale with negative equity. Long tunnel – no light.

In European news, Royal Bank of Scotland shares were hammered last night as the leading UK commercial bank announced a rights issue to raise US$24bn in capital to shore up the bank’s balance sheet. The market is now nervously awaiting moves from Barclays and HSBC.

In Australia this morning ANZ Bank ((ANZ)) will announce its half-year result. The first quarter CPI is also released this morning.

The SPI Overnight fell 21 points.

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