Daily Market Reports | May 21 2008
By Greg Peel
The Dow fell 199 points or 1.5% to 12,828, crashing back through the 13,000 level once more. The S&P fell 0.9% to 1413, leaving its technically significant level of 1420 behind. The Nasdaq also fell 0.9%.
Although the Dow recovered 57 points from its intraday low by the close, it was mostly one-way traffic. The day began with eyes glued to a CNBC interview with legendary oil billionaire T. Boone Pickens. Pickens suggested there was a gap between oil supply and demand at present that was simply not being filled, and he predicted the crude price would reach US$150/bbl before the end of the year. Pickens is backing his belief by investing heavily in renewable energy.
By the end of the day the oil price had rallied another US$2.02 to US$129.07/bbl. It was not all about Mr Pickens. OPEC again indicated it would not be raising production, although Saudi Arabia has been very temporarily increasing its output to offset lost production from Nigeria – another OPEC member. But Nigeria’s oil is sweet and light and highly sought after for automotive products. The fresh Saudi oil is sour and heavy and requires further refinement before it is useful. That’s one reason we have inventories of crude backing up while refineries are running only at 82% capacity in the US. With the shortage of sweet crude, diesel and heating oil production is failing to meet demand.
China has also become more of a problem, not just because the earthquake’s impact but because 32 of China’s power stations are sitting idle due to a shortage of coal. The government has had to revert to more expensive diesel powered generation to make up the shortfall, and analysts expect this extra oil demand will continue right through to the Olympics in August.
Maybe the closing ceremony will signal the peak in demand for many commodities – a prediction that’s been made for more than a year.
The impact of the soaring oil price was driven home on the release of the April producer price index number earlier in the session. The core rate came in at 0.4% – double what economists had expected. The new annualised rate of 3% is the highest since 1991. The headline reading, including food & energy, rose 0.2%. The effect of rising oil is now evident not only as a primary price mover – at the pump – but as a secondary price mover – affecting higher prices in all transported goods.
The equivalent April CPI released last week caused the world to scoff at its low reading, affected by a “seasonal adjustment” that saw the oil component fall a full 2%. While some traders were happier to believe the number so they could buy stocks, the cynics were at least appeased by explanations that this seasonal adjustment will work in the opposite direction later in the year. It was simply a smoothing of reality.
With the PPI creeping up, the next step is to see higher costs passed through to consumers. Retailers can only take so much margin squeeze. Home renovation retailer Home Depot last night reported a 66% fall in profit in the first quarter, sending its shares down 5%. Discount retailer Target was not immune either, showing a profit decline of 8%. Its shares lost over 1%.
The Chicago Fed announced economic activity in its sector weakened in April to its lowest level since the 2001 recession.
And there was more negative speculation for the financial sector. Oppenheimer’s famed bank analyst Meredith Whitney must suffer from bouts of sharp stabbing pain these days, as financial firms stick pins in little Meredith dolls. Last night Whitney suggested the credit crisis would extend into 2009, and “perhaps beyond”. She suggested the US$25bn that has been set aside by the big banks, such as Citi and JP Morgan, would need to climb to US$170bn by next year.
Financials were a big part of last night’s fall. Not helping was a statement from Fed vice chairman Donald Kohn hinting that rates were now on hold. This is not good news for the financial sector looking for further rate-cut relief. The irony here is, however, that last month the market was euphoric about the thought that rates would not be cut further, as it implied the Fed was satisfied the worst was over in the financial crisis. However, an “on hold” position is really only a trade-off between ongoing liquidity issues and rising inflation.
And it is rising inflation that is coming home to roost.
The US dollar took a major tumble on the PPI figure. If this were Australia, we’d be expecting the RBA to raise its rate. This would be positive for the Aussie dollar. But it’s the US, and ongoing financial sector problems and the recession mean the Fed cannot raise rates. Hence the greenback fell heavily as the impact of inflation on the consumer was factored in. The euro shot back to US$1.56, and will probably now take another run at US$1.60. What happens then is unclear. Intervention?
Gold has decided it’s back to business, rising another US$14.10 to US$918.70/oz. Gold has bounced hard from the US$850 level as the spectre of inflation has been driven by the oil price. It’ all about speculation. The World Gold Council reported last night that gold ETF demand doubled in the first quarter, while physical (jewellery) demand fell 16%.
The Aussie continues into quarter-century record levels, up another half a cent over 24 hours to US$0.9587. One might say look out parity, but look out exporter earnings downgrades is possibly more apt.
Base metals are still stuck in an Arthur-Martha range of competing influences. A high PPI in the US is bad for consumers, thus bad for the economy, thus bad for metal demand, but then there’s Chinese demand, the earthquake, the rising oil price and the weakening US dollar. All up the metals went mostly nowhere.
The SPI Overnight fell 78 points. Keep an eye out for 5700, but not today. If that goes, then 5500 will be a big, solid concrete floor. The sort you could probably build a launching pad on. “Sell in May”? Let’s not get ahead of ourselves.
