The Overnight Report: Saudi Scramble

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By Greg Peel

The Dow fell 107 points or 0.9% while the S&P fell 0.6% to 1307 and the Nasdaq dropped another 1.2%.

It started with one man's suicide protest in Tunis and now, by the virtue of the internet and social networking, it has spread across the Arab world led by disaffected youth who are exponentially better informed than their parents were at their age. In the Kingdom of Saudi Arabia, it is considered bad taste to protest against the otherwise popular King Abdullah. But in a kingdom in which petrodollars flow like water, 45% of 20-24 year-olds are unemployed. Riyadh is now rumbling.

The aging King Abdullah returned last night after three months convalescence and immediately announced a US$36bn package of social reforms. It's nice to have a handy US$36bn lying around – Wayne Swan would have kittens. One might ask why it's taken 50 years of being the world's largest oil producer to suddenly decide to drag the population out of poverty. The answer, of course, is that previously there was no sign of revolt.

Prior to Abdullah's announcement, media outside the kingdom picked up Twitter and Facebook flow rallying the Saudi youth to protest. The oil price soared as a result. Brent crude has jumped US$5.44 to US$111.25/bbl. Abdullah's reform package offered some relief but of course we have a madman loose in Libya to contend with as well. He appears to have lost control of his country, but he intends to go down fighting.

The big move up in the price of oil is very destructive for the global economic recovery. However, at this stage it is very much a rally on fear. Experts agree that whoever grasps power in any Arab oil producing country will not turn off their only source of viable income. Indeed, the tribal chiefs who have wrested control of eastern Libya have declared that their first task, once Gaddafi is overthrown, will be to turn the oil back on.

So this spike, in theory, should not have legs. Saudi Arabia supplies only 10% of US oil needs, with the bulk of imports coming from Canada, Mexico and Venezuela. OPEC supposedly stands ready to counter any lost production, although OPEC is very much a say-one-thing-and-do-another organisation. But US$100+ oil is not attractive to OPEC when it causes demand destruction.

At lunchtime the Dow was down 150 points with oil cost as the sole driver. The release of January existing home sales showed a better than expected 2.7% rise, but this was lost in the wash. Besides, Tuesday night's Case-Shiller release showed US house prices are still falling. Saudi reforms were some comfort and Wall Street tried to bounce back in the afternoon, but the bounce was not convincing.

Meanwhile over in the UK, the minutes of the recent Bank of England monetary policy meeting showed that at least one member was pushing for a rate rise given rising inflation. The European Central Bank has also been hinting a rate rise might not be too far off. The rise in the oil price only adds to inflation fears. Gold thus rose US$12.10 to US$1410.00/oz last night. Silver rose 1% to US$33.48/oz.

Reports also suggest the eurozone nations are getting closer to a resolution with regards to tackling sovereign debt issues. Throw in the continuing popularity of the Swiss franc as a safe haven and the US dollar fell 0.5% last night to 77.40 as the pound, euro and Swissy were sought.

With QE2 overhanging, the US dollar is not being sought. Nor were US five-year notes popular last night at the Treasury's US$35bn auction. Weaker than expected demand saw the benchmark ten-year yield bounce back three basis points to 3.49% after Tuesday's big drop (in yield).

The uncertainty in the Arab world is translating to uncertainty in markets. While oil rose, sending Wall Street down last night, the risk trade exodus stalled. Base metals in London were relatively steady. The Aussie has recovered half a cent to US$1.0031. Precious metals found buyers once more. US bonds were not swamped.

The Australian market did not follow through with significant weakness yesterday. Construction work done in the December quarter rose a weaker than expected 0.8% with building, as opposed to engineering, still very weak. Fourth quarter wages nevertheless rose a slightly more than expected 1.0%, once again encouraging rate rise talk. One assumes that construction numbers in this quarter will be a different kettle of fish, one way or another, given the level of natural disaster.

What is the trade here? There are those expecting further oil-related weakness in stock markets and those calling misguided overreaction. This may well be a great buying opportunity, but the situation is fluid. The VIX in the US ticked up another 5% to 22 last night as investors again sought protection. There are those who remember the oil shocks of the seventies. But it is a rather different world today. Still, the word “stagflation” is back from its hiatus since 2008.

The SPI Overnight was down 23 points or 0.5%.

While yesterday's local construction work numbers will have economists tweaking their fourth quarter GDP estimates (released next Wednesday), today's capital expenditure numbers will be more telling. It's also another huge day of profit reports today, with Downer EDI ((DOW)), Fairfax ((FXJ)), IAG ((IAG)), Origin ((ORG)) and Toll Holdings ((TOL)) among the highlights.

Tonight in the US sees durable goods, the FHFA house price index and new home sales. But response will all depend on developments abroad.

Rudi will be make his regular appearance on Lunch Money today on the Sky Business channel at midday.

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