The Overnight Report: Oil Tanks

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By Greg Peel

The Dow closed down 5 points while the S&P rose 0.2% to 1877 and the Nasdaq gained 0.3%.

Well I made the call yesterday morning that Bridge Street probably wouldn’t follow down Wall Street despite a big drop in the Dow, but I wasn’t exactly calling a 50 point rally. It was all about the miners nevertheless, given the materials sector stole the show with a 2.6% rally in the wake of the three dollar bounce in the iron ore price. The banks, the supermarkets and the telco all found some support as well.

The data don’t seem to matter much in this volatile period, but for the record the NAB business confidence survey for September showed a drop in conditions, down 2 points to plus 1, and a drop in confidence, down 2 points to the long-run average of plus 5.

The data that really mattered last night came out of Europe, where eurozone industrial production fell 1.8% in August against expectations of a 1.6% fall. The bulk of the decline was attributable to Germany’s 4.0% drop, announced last week, and a lot the blame for that can be placed at the feet of Vladimir Putin. Tony Abbott might “shirt-front” the Russian president this weekend, but Angela Merkel will probably deck him.

The German government last night cut its 2014 GDP growth forecast to 1.2% from 1.8% and 2015 to 1.3% from 2.0%. Germany’s ZEW investor sentiment survey for October showed a fall to minus 3.6, down from plus 6.9 in September, missing forecasts of plus 0.8, and representing the first drop into the negative in two years.

There were no signs of shock on the European bourses nonetheless, which have already been clobbered. Both the German and French indices posted mild gains. This was not the case in London, where the FTSE fell 1.6%. Having appeared to be leading the developed world economic recovery in a post-Olympic haze, the Brits were somewhat shocked with a fall in headline CPI inflation in September to 1.2%, down from 1.5% in August to mark the lowest level since September 2009.

Headline CPI numbers are nevertheless retreating rapidly around the globe because energy prices are retreating rapidly. Last night the International Energy Agency cut its global oil demand growth forecast to the lowest level in five years. The IEA expects oil demand to fall to 700,000bpd this year, down from a previous estimate of 900,000bpd, while last month global production rose to 910,000bpd.

While I suggest the next commentator on business television to say “the world is awash with oil” should be taken out and shot (I heard it three times this morning alone), the truth is the analogy is accurate. OPEC is currently dumping cheap oil on the market to overcome the impact of accelerating US shale production. The world has been expecting OPEC to announce production cuts at its meeting next month in order to put a floor under oil prices but last night Saudi Arabia suggested Brent crude “should be at US$80/bbl”. The hint here is that perhaps OPEC will not cut production, given (a) it is not OPEC causing the supply glut, so why should OPEC make the sacrifice, and (b) even if OPEC were to cut production there’s no guarantee it would work if North America just keeps pumping with gay abandon. OPEC may not like a lower sale price but the fact is most of its production is very, very low cost compared with much higher cost shale oil recovery. The question is at what price are the first marginal US shale producers forced to shut down?

Perhaps OPEC is willing to find out. Last night Brent fell US$2.99 to US$85.12/bbl and West Texas fell US$3.18 to US$81.94/bbl.

Oil was not the only asset to capitulate last night. The flight to safety in the form of US Treasuries stepped up a notch, in the face of sliding global growth, with the ten-year yield falling 8 basis points to 2.21%, a 16-month low. How’s that Fed rate rise looking? The German equivalent is now at 0.795%.

The flight to bonds became overwhelming for US stocks markets during last night’s session, killing off attempts at a rebound out of Monday night’s technical rout. The Dow was up 140 points at midday but could not hold on, although the session ended with the Russell small-cap index posting a 1% bounce. The Russell is nevertheless already in correction territory and very volatile, so no one’s brave enough to call a bottom just yet.

Early strength was attributable to last night’s quarterly earnings results, which saw earnings beats for Citigroup and Johnson & Johnson (Dow) and a revenue beat for Wells Fargo. JP Morgan’s (Dow) similarly strong result was undermined by a billion dollar legal fee provision, while after the bell Intel (Dow) also posted a strong result.

It is interesting to note that Domino’s Pizza Inc – the US parent which has no equity connection with our local variety – blew them away with its result and posted an 11% rally. Sound familiar?

The weak eurozone data pushed the euro lower and thus the US dollar index higher last night by 0.4% to 85.81, helping the Aussie down 0.6% to US$0.8710. Gold was steady at US$1232.60/oz.

Base metal markets are currently wrestling with their own supply constraint issues against a backdrop of lower global growth and a stronger greenback. Base metals were hitting lows long before iron ore and crude began their retreats but speculators are short, which was evident in a 0.9% jump for copper last night despite all the global doom and gloom. Tin nevertheless fell 2.5% in an up and down market.

After its big rally on Monday night, iron ore is unchanged at US$83.10/t.

The SPI Overnight closed down 4 points.

I think I’m right in saying yesterday’s 1% bounce on the local bourse is the fourth such single-session fight-back since foreign selling tipped us over last month. But each of the previous incidents were followed by a 200-300 point fall in the Dow that night, to send the buyers packing once more. This time it’s different! Although I’d be keeping an eye on the energy sector today.

There’s also a torrent of data to absorb over the next 24 hours.

Locally we see the Westpac consumer confidence index and a production update by Rio Tinto ((RIO)), while Japan posts industrial production and China posts inflation numbers. The eurozone flash CPI for September is out tonight while in the US, retail sales, inventories, the PPI, Empire State manufacturing index and Fed Beige Book all make for a busy schedule, alongside more earnings results.

Rudi will appear on Sky Business at 5.30pm.
 

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