Daily Market Reports | May 22 2008
By Greg Peel
The Dow fell 227 points or 1.8% to 12,601. The S&P fell 1.6% to 1390, leaving behind the psychological level of 1400. The Nasdaq fell 1.8%.
Early this morning crude oil for July delivery traded at US$134/bbl in the electronic aftermarket on Nymex. The day-session closed at US$133.17/bbl, up US$4.19. Last night the June contract rolled into July. Under normal circumstances, the traditional backwardation of the forward curve would ensure a slight step back in price on a monthly rollover. This has been the case, right up to the July contract. However, the rollover from June was virtually flat. The oil curve is now in contango.
What this means is despite the “cost of carry”, which is basically the financial cost of storing oil, demand for longer dated contracts has pushed those prices above the spot price. The first-glance implication here is that buyers are assuming the price of oil to be higher into the future. But once again, who is driving this market?
It was only last week FNArena was pondering oil at US$125 and debating whether the speculators had overridden supply/demand fundamentals. We are now at US$134, which means oil has risen US$44 or 49% in 2008. It has risen US$20 in a month, and US$7 in two days. It has, to use trader-talk, “gone parabolic”. What usually follows a parabolic up-move is a “blow-off top”. As investment money pours in to oil and commodity ETFs, the latest moves do look very speculative. One is reminded of gold in May 2006.
One factor to note is that the share prices of oil producers have turned down. Shares of Dow component Exxon lost close to 1% last night. Yesterday in Australia, shares of Woodside Petroleum ((WPL)) lost 0.5%. Investors are finding it hard to buy oil stocks at what may prove at least a temporary top in the oil price. But even if oil falls by around US$25, we still have oil at around US$110. If this is entrenched, then it is still a harbinger of economic contraction.
The catalyst for oil’s particular move last night was the weekly US inventory data. It showed a slight fall in inventories when expectations were for a gain. Weekly inventory numbers fluctuate with abandon, and many pay scant heed. But the market is in one of those moods where anything is taken as bullish. Also assisting oil’s rise was another big down-night for the US dollar.
The minutes of the last Fed rates meeting were released last night – the meeting that cut the funds rate by 25bps to 2%. At the time, Wall Street decided the hint was no further cuts. This was very well received by the market, as the implication was that financial troubles had eased. Well the minutes revealed that the hint was no hint at all. It was a cut and dried confirmation. The Fed will not be cutting rates again.
The reason is headline inflation. The Fed has finally decided it must let the economy and the still-fragile financial markets loose and turn its intention to soaring food and oil costs, and subsequent inflation. The central bank raised its inflation forecast for 2008 a full percentage point from 2.1-2.4% to 3.1-3.4%. It does not expect any easing of inflation until 2009.
That the Fed would not cut rates might otherwise be positive for the US dollar, except that the Fed’s economic growth forecast was cut from 1.2% in 2008, all the way down to a mere 0.3%. This is what sent the greenback tumbling. The Fed has no further capacity to cut rates to save the economy because the inflation threat is now too extreme. The Fed also increased its unemployment rate expectation from 5.2-5.3% in 2008 to 5.5-5.7%. That’s bad news for consumer spending. Put those three adjustments together, and you have nothing less than stagflation.
It was the Fed minutes that really sent the Dow into the red as well. The financial sector was particularly badly hit. Apart from being – to some extent – now abandoned by the Fed, a report circled claiming ratings agency Moody’s had accidentally assigned AAA ratings to certain subprime securities back before 2007 due to a “computer glitch”. Moody’s did not confirm this report, but its shares fell 14%. The Wall Street Journal further reported that both Lehman Bros and Morgan Stanley were about to announce a round of second quarter losses which were specifically due to losses on hedging set against leveraged loans and real estate securities. Lehman is supposedly set to announce US$2bn in losses, and Morgan US$1bn. Lehman shares lost 6% and Morgan 4% as the whole sector was dragged back towards previous lows. Bank of America did hit its previous low.
With the US dollar falling again – the euro reached US$1.5791 – gold was again strong, gaining US$13.00 to US$931.70/oz. The Aussie has broken through 96, trading up half a cent in 24 hours to US$0.9637. This is not good news for exporters in Australia, including commodity exporters.
Confusion still reigns on the LME, with the influence of a weak US dollar being offset by its cause – a slower US economy. As it was, metals undecidedly did their own thing, with nickel falling 4% and zinc 3% while copper only had a slight fall and aluminium and tin rallied.
The SPI Overnight was down another 73 points.
What might stop oil? There are a number of possibilities, but the most ominous from an oil bull’s perspective would be some sort of exogenous influence. There is concern about trading rules on the Nymex. While oil sails around the world in barrels, the real price action is determined on the paper-traded futures market. A futures exchange, if concerned about a high level volatility, can readdress rules on trading limits and margin costs. This happened in 2006 with copper, and copper fell sharply.
There is also the US Strategic Oil Reserve. The Bush Administration has come under heavy criticism lately for continuing to top up the Reserve despite high prices. It was seen as only exacerbating the rise. Congress has since passed a motion to prevent the government from buying any more oil for now. How long before it tries to pass a motion that the government should release oil in order to force the price back down? Bush – an oil man – would undoubtedly veto such a directive. But the mere thought might have its own influence.
And while we’re on the subject of volatility, that VIX index of which I have spoken in recent reports has rebounded heavily off its lows – lows that had experienced traders warning of complacency – and shot back up again. The put buyers are back.
