Monday, February 27, 2012

February, Monday 27, 2012

DOW – 1 = 12,981
SPX + 1 = 1367
NAS + 2 = 2966
10 YR YLD -.06 = 1.92%
OIL – 1.07 = 108.70
GOLD – 5.50 = 1769.10
SILV +.05 = 35.56
PLAT – 3.00 = 1711.00

Let's look at the price of a gallon of gas and the factors that have been pushing prices higher. You may recall that last May, oil prices moved up to $114 per barrel. So one of the first considerations is that this is a seasonal move. You will also recall that last spring, the oil production in Libya was disrupted. After a while, Khadafi was deposed and by last October, prices had dropped to $75 a barrel.

Now the concern is Iran, and any disruption in Iranian oil supply would be considerably larger than Libya, and might lead to even more widespread disruption of oil transportation through the Strait of Hormuz. Iran produces about 4.3 million barrels per day. So, now we are looking at the imposition of sanctions on Iran. What are the implications? The most likely result of sanctions is that the countries participating in the sanctions would have to cut back demand and find new sources, and the countries not participating could buy the oil from Iran. China and India would buy more oil from Iran, while Europe would buy more oil from Saudi Arabia. There would still be the same amount of oil in the global market, just have to buy it from different sources.

Maybe sanctions could alter global production, or maybe the situation deteriorates and we end up with disruptions; what happens then? Well, we can look back to the Iran-Iraq War in 1980, the first Gulf War in 1990; these wars disrupted oil supply, taking out 4-7% of net world production and resulting in oil price increases of 25% to 70%. What follows a sharp spike in oil prices? Recession in the United States. Some people theorize the US is less susceptible to oil price shocks than in the past. If the Strait of Hormuz is closed, even if for a day or two, we'll get a good test of that theory.

The Murdoch Street Journal speculates that monetary policy is to blame.  “Oil staged its last price surge along with other commodity prices when the Fed revved up its second burst of "quantitative easing" in 2010-2011. Prices stabilized when QE2 ended. But in recent months the Fed has again signaled its commitment to near-zero interest rates first through 2013, and recently through 2014. Commodity prices, including oil, have since begun another surge, and hedge funds have begun to bet on commodity plays again. John Paulson says he's betting on gold, the ultimate hedge against a falling dollar.”

There might be something to this argument, loose monetary policy tends to lead to inflation; oil is priced in dollars. The reality is that most commodity prices haven't moved much in the past six months. Oil was up 22% in the 4th quarter of 2011; copper gained 4% in that time. Most of the agricultural commodities were largely unaffected by the Federal Reserve. The Fed's efforts to stimulate the economy probably have some effect and they might even swing out of control, but we're not seeing that right now.

I don't quite follow this argument I've been hearing about the Fed causing higher oil prices. In order for that to be true, wouldn't the markets have to expect a fall in the value of the dollar? And doesn't that imply inflation? If the oil markets expect inflation, then why don't the bond markets? The dollar Index is pretty much where it was last October, and pretty much where it was in October 2010. I doubt the Murdoch Street Journal is trying to claim the Fed has stimulated the economy so much that demand is now smashing available supply.

While there is evidence the economy is improving, one of the twists is that gasoline demand is waning. There are three explanations for this anomaly. First, as the economy has improved we have seen an increase in car sales and those new cars are much more efficient – Second, as the price at the pump has increased Americans have cut back driving (we've done this before and we are learning how to improve our efficiencies), and third, the improvements in the economy aren't real and the economy is contracting rather than growing. Take your pick.

As best I can figure, economic activity is improving in the US but not by much, still that might account for a modest increase in oil prices except that demand for gasoline has dropped in the US. So, let's toss in an improving outlook for economic activity in Asia. Aside from production disruptions, or fear of them, global economic activity has to be the key driver of oil price changes. A very small change in outlook for the next five years would justify a significant change in current oil prices. The reality is that since 2005 we have seen virtually no increase in global crude oil production and total petroleum liquids. You should expect that prices would rise over time. Demand has increased a little and supply has been flat, but that is the long term outlook.

Still, that doesn't explain the jump in prices that we've seen since October. Gas prices are back to levels that we last saw in the summer of 2008. Remember when oil hit $147 a barrel? Today, we only – ONLY – see prices pushing up against $110 per barrel. And that brings us to a major inefficiency that is pushing prices at the pump much much higher.

As prices for oil have moved higher, domestic demand for gasoline has dropped to a 15 year low. The result is a squeeze on refineries. Since December, the U.S. Has lost 4 percent of its refining capacity. Two major refineries in Pennsylvania shut down, so there has been a significant impact on refined supplies, especially in the East. Still, domestic oil production has increased over the past three years, and the offshore oil rig count is now 2.5 times higher than the previous 10 year high, and refineries are exporting gas, one of our major exports now in the U.S.

So, let's only presume that prices are impacted when non-North American oil supplies are threatened or there is the threat of a threat.
Then markets wisely react to possible supply reductions as opposed to ongoing domestic and North American supply restrictions. Which further makes the case for reducing North American oil production because such production is irrelevant to oil prices and can only cause all of the ground water in North America to be contaminated.
No wait. There must be a better answer. Speculators hold 70% of the open interest in oil futures. If the CFTC actually enforced it's rules, speculators would only be allowed to hold 30% and the price of oil would reflect supply and demand.
And if you want to know the real reason why we can't seem to get a serious commitment to sustainable, renewable energy the answer is that the bankers haven't figured out how to control it and take their cut.

In December, Anonymous may have hacked into security data of Stratfor, a Texas-based intelligence and threat analysis firm, that has been described as a shadow CIA. Today, Wikileaks dumped 5-million Stratfor emails; they call them the “Global Intelligence Files”. According to Wikileaks, the emails “reveal the inner working of a company that fronts as an intelligence publisher, but provides confidential intelligence services to large corporations.” Wikileaks name-checks several Fortune 500 corporations as well as U.S. government agencies

Wikileaks claims the emails”show Stratfor’s web of informers, pay-off structure, payment laundering techniques and psychological methods,” adding that the emails “expose the revolving door that operates in private intelligence companies in the United States” and alleging that government-related sources around the world give Stratfor political scoops in trade for cash.

WikiLeaks founder Julian Assange told Reuters: "Here we have a private intelligence firm, relying on informants from the U.S. government, foreign intelligence agencies with questionable reputations and journalists. What is of grave concern is that the targets of this scrutiny are, among others, activist organizations fighting for a just cause."

Among the more disconcerting emails, one involving a Goldman Sachs Managing Director looking to utilize the intelligence to form a hedge fund and trade on what I think might be considered insider information. Another email indicates that Stratfor attempts to use financial, psychological, or sexual control of informants or possibly people being investigated. Which makes the story of Julian Assange all the more intriguing.

I'm still waiting on the Wikileaks dump on the big banks. Assange has been promising that for almost two years, during which time, the infrastructure for funding Wikileaks has broken down. I don't know whether Assange is a saint or a sinner but it sure looks like some very powerful people have been trying to put a lid on his work.

The potential drag from fiscal restraint contributed to the rationale behind Federal Reserve policy makers’ reduced forecasts for growth this year and in 2013, that is part of what we learn from the minutes of the January FOMC meeting. Put another way, the fact that we have a dysfunctional fiscal policy is a contributing factor to why we have such extraordinarily accommodative monetary policy. Fed Chairman Bernanke returns to Capitol Hill on Wednesday to deliver his semiannual report to the  House Financial Services Committee. There are several programs that are set to expire around the end of the year. Bernanke's expected to tell Congress to pursue a long-term outlook on balancing spending and revenue, but no sudden moves.

The Federal Reserve Bank of New York issues a quarterly report on Household debt and credit. The latest finding from the fourth quarter show most households are continuing to delever. Aggregate consumer debt dropped $126 billion to 11.53 trillion. Consumers’ non-real estate indebtedness now stands at $2.635 trillion.  The report finds that $1.12 trillion of consumer debt (or 9.8 percent of outstanding debt) is currently delinquent, with $824 billion seriously delinquent (at least 90 days late). So, I think I understand; foreclosures and delinquency tends to decrease outstanding debt.
And when you decrease outstanding debt, you increase net worth. So, if you're looking for a quick way to increase your net worth - I'm just saying, you do the math.

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