The Overnight Report: Sell China, Buy Oil

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By Greg Peel

The Dow closed up 61 points or 0.7% while the S&P gained 0.7% to 996 and the Nasdaq also added 0.7%.

It was a rather bizarre session on Wall Street last night – one which begs the question of who is leading who. From the opening bell, the Dow was down 86 points. By 11.45am it had clawed back that drop to be down only 17. At 12.10pm, it was suddenly up 85 points, before drifting in the afternoon to the close of up 61.

A late positive earnings report from Hewlett Packard on Tuesday evening in New York had provided possible impetus for Wall Street to open to the upside on Wednesday. However, Wednesday’s session in Asia was dominated by yet another big fall in China, in which the Shanghai index dropped 4.3% following Monday’s 5.8% decline. The Shanghai index is now down 20% in a month, and down net 10% from the point at which the S&P 500 started rallying to be up 13% in its second leg.

The fall in China was attributed to disappointment that the government was doing nothing to stop the fall in China. This is somewhat ironic, given the fall in China began when rumours circulated that the government would move to stop the rise in China. The local market assumed the government would be forced to tighten its loose monetary policy in light of a 100% rally in the index from its GFC depth. Thus it began to fall. Nothing ever happened, but now a still largely inexperienced investment fraternity expects the government to step in a save the stock market. With what? Even looser monetary policy?

The reality is China has been funnelling stimulus funds via the banks by setting a low cash rate. The funds are intended to finance construction and business investment, but a lot of it has simply found its way into stock market speculation. It is no doubt true the government would have been concerned about another bubble, yet also true the government wants to keep up loose monetary policy at least until the West recovers and export demand returns. What would be the best way for the government to deflate the stock market bubble?

I wonder who started the rumours?

Wall Street has seen this movie before. Shanghai fell nearly 6% on Monday to spark a big Wall Street sell-off, but Tuesday brought a fairly solid recovery. When the market opened lower last night it didn’t take long for the buyers to return, once again hoping such a dip proves to be an opportune entry point.

If buyers were at all cautious, it was all thrown to the wind just before midday when the Energy Information Agency announced its measure of the level of US crude inventories as at a week ago. The market had been expecting a 1.1m barrel rise for the week, but instead there was an 8.4m barrel drop.

Now, obviously these numbers come out every week, and every week Nymex holds its breath, despite unsurprising vagaries of weekly volatility. I don’t ever remember a week when the news was “the change in weekly oil inventories met expectations”, although possibly because that isn’t particularly newsworthy. But it seems that every week inventory numbers appear rather different to expectations, which tends to cause gyrations in the oil price. Sometimes, however, the oil pit ignores inventories altogether, particularly when the stock market has a strong day.

Indeed, US crude inventories have reached to around record highs while the oil price has risen from US$32 to US$72.

Ask any oil trader at present why oil is up here, and he’ll tell you because oil is following the stock market. The stock market is indicating economic recovery. Given a rising stock market currently means a weaker US dollar, that also helps oil’s rise. Last night oil jumped US$3.23, or 4.7%, to US$72.42/bbl to its highest level since June. When oil shot up on the inventory news, the stock market leapt about 100 Dow points in a heart beat.

Who was leading who?

The other interesting point to note is that there are two factors which cause a fall in inventories, if one assumes there is constant weekly consumption. Either more oil has gone out or less has come in. Less coming in implies a drop in import orders, and import orders are most likely to drop at this time not because of weak supply – because there’s plenty of that – but of weak demand. Analysts noted last night that the reason for the rather substantial 8.4m barrel inventory drop was because imports were down for the week.

But Wall Street will take any excuse at the moment. Last night the US dollar fell when the stock market went up and stock market went up because oil went up and another reason oil went up is because the dollar fell. It fell ultimately to 78.51 on the index.

Once again one might assume that if oil surges, aided by a weaker US dollar, then a similar result should occur in base metals. But no – once again base metals have struggled to join in the fun.

On the London open last night – before Wall Street’s open but after Shanghai’s close – base metals crashed on the LME. Aluminium was down over 6% at its lows, further weakened by the news inventories had hit a new record high. Copper dropped 4.3%. It was only the Wall Street/Nymex jump that saved the day, no doubt sparking some short covering. Aluminium closed down 2% and copper 0.5% while nickel, lead and zinc managed around 2% gains by the close.

Gold took its lead from the US dollar, rising US$4.40 to US$942.50/oz. If I were a Comex trader I’d be taking a book to work these days. The Aussie ticked up slightly to US$0.8289.

The SPI Overnight was certainly revved up – rising 48 points or 1.1% despite only a 0.7% gain in the S&P 500. The ASX 200 does have a large energy weighting, but so does Wall Street and it was stocks like Exxon and Chevron leading the charge last night. The big jump would be more attributable to the fact we failed to rally yesterday given China fears and despite the recovery rally on Wall Street on Tuesday night. It looks like a bit of catch-up.

Strap yourselves in for earnings watch today. Among 21 reporting stocks in our calendar many are ASX 200 stocks, including AMP ((AMP)), Brambles ((BXB)), Lend Lease ((LLC)), OZ Minerals ((OZL)), QBE Insurance ((QBE)), Santos ((STO)) and Wesfarmers ((WES)).

For the full list of reporting dates and major economic data releases please refer to the FNArena calendar.

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