Currency/Commodity Markets
Nov. 1 (Bloomberg) — OPEC’s decision to increase oil production, which took effect officially today, is failing to stop surging oil prices because there is no real supply shortage in the market, the group’s ministers said.
Nov. 1 (Bloomberg) — Exxon Mobil Corp., the world’s largest oil company, said quarterly profit unexpectedly dropped the most in three years on reduced gasoline output and prices.
Exxon’s third-quarter earnings per share fell 4 cents below the average of 16 analyst estimates compiled by Bloomberg after gasoline prices in the U.S. dropped almost 6 percent. As fuel prices slumped, oil rose above $80 a barrel for the first time, squeezing the gap between crude costs and gasoline and diesel prices. Narrower margins and disruptions to fuel output on three continents outweighed Exxon’s gains from record oil prices.
We have included two news stories above. The first is yet another comment from OPEC that there is, in fact, no apparent shortage of crude oil. There may be a shortage of crude oil futures contracts (we wonder how this might change if buyers actually had to take delivery) but that is another story. U.S. commercial inventories are declining because near-term prices are too high and prices are rising because inventories are declining.
Our concern at present has to do with spreads and ratios. Natural gas prices are now rising quite briskly and the most common explanation is that gas is ‘cheap’ relative to crude oil. As of yesterday U.S. gas inventories totaled 3.509 trillion cubic feet. Since 1993 the average heating season inventory draw down has been, we understand, just over 1.9 trillion cubic feet. Barring the complete collapse of the entire global warming argument... there will be no shortage of natural gas this winter yet prices continue to rise.
The chart at top right compares the spread between December 2007 and March 2008 crude oil futures (above 0 means the market is in backwardation) and the ratio between crude oil and gasoline futures.
The crude oil/gasoline ratio tends to peak around .41. If gasoline is at 2.35 then crude oil is no higher than about 96. If gasoline is 2.00 then crude oil is 82 and so on.
Last year the ratio hit the top of the trading range in early September and then declined all the way back to .27. At 2.35 gasoline this would mean 63 crude oil and at 2.00 gasoline crude would be back to 54.
Our concern is that the ratio adjusts down from .41 towards .27 for a different reason- sky high gasoline prices. The Exxon Mobil news suggests that the refiners are getting squeezed at current relative prices and the rational response would be to slow the pace of refining. This would reduce the demand for crude oil but would ultimately create another shortage for gasoline.
If all goes well the ratio will resolve lower through falling crude oil prices and this will result in the sort of markets response that we saw last year in September. Notice that the Cdn dollar turned lower as the airlines (AMR) began to fly. Once again the bullish equity markets outcome revolves around lower crude oil instead of higher gas, gasoline, heating oil, etc.
Short-Term Views
The chart at top right shows the S&P 500 Index (SPX) and the ratio between crude oil futures and the TBond futures.
The idea is that the equity markets tend to bottom at the peak for the crude oil/TBonds ratio. This year has been somewhat unique in that interest rates have been falling even as oil prices have spiked upwards. Consider how negative the equity markets would be (i.e. 1990) if interest rates had risen all year.
In any event the SPX could certainly decline towards the 1470 level without much difficulty. As long as the trend for crude oil prices remains higher the trend for the financials will be lower.
The chart below compares Merrill Lynch (MER) with U.S. TBill yields.
MER is ‘stair stepping’ lower in 10-point increments. 60 is the next support level and we expect that it will not hold if crude oil is actually going up through 100. Our thought here is that crude through 100 and MER below 60 will lead into a state of rather dramatic crisis similar to this past August. Nervous times indeed.
Meanwhile we commented yesterday that while oil price are rising it was still our view that copper prices were far too high. Based on our copper plus 3 times crude oil combination we show the spread between copper MINUS 3 times crude oil at bottom right. This decade the spread has moved back and forth through the ‘0’ line suggesting that copper at 3.35 is equivalent to crude oil at roughly 110. The rally in the Chinese shares market began back in 2005 when copper prices started to outperform. A rather bearish chart for Asian stock prices...
