Monday, July 08, 2013 - Nothing Recedes Like Progress

Nothing Recedes Like Progress

by Sinclair Noe

DOW + 88 = 15,224
SPX + 8 = 1640
NAS + 5 = 3484
10 YR YLD - .07 = 2.65%

OIL - .17 = 103.05
GOLD + 13.50 = 1238.30
SILV + .18 = 19.18

Took a little break for the Fourth of July, so we have some catching up to do. Friday morning the jobs report showed the unemployment rate holding steady at 7.6%, even as the economy added 195,000 jobs. Better than expected but not good enough; possibly proving the adage that nothing recedes like progress, or at the very least we know that the path of progress is neither swift nor easy. More than 8 million people are working part-time for economic reasons; nearly 3 million are working in temp jobs; more than 4 million are in the ranks of the long-term unemployed; more than one million are considered discouraged, they've just given up I suppose.

If the labor market holds steady and job creation continues at the current rate, the unemployment rate will dip below 7 percent sometime in mid- 2014; by which point the majority of American workers will be part-time. We really should be adding more than 300,000 jobs a month, not fewer than 200,000. As the Economic Policy Institute points out, we would need more than five years of job growth at this rate to get back to the level of unemployment that prevailed before the Great Recession.

Still, the 195,000 new jobs should boost expectations for growth and inflation, which tends to push up bond yields. That happened on Friday; yields on the 10year Treasury note bounced up above 2.6%. The concern is that the Fed will ease up on Quantitative Easing as the unemployment picture improves, and the Fed seems to think the economy is strong enough to handle it. But the feral hogs in the bond market smelled blood and they priced in the Fed stepping back, not caring whether the economy can handle it or not.

Ironically, the market's moves could slow down the economy enough to make the market's prediction wrong, by hurting the economy so much that the Fed realizes it can't taper its bond purchases yet. And if the markets don't squash a recovery, then the politicians might. The austerity gang remains staunchly opposed to any deliberate job creation program. The Federal Reserve seems more interested in testing the idea of tapering than any aggressive monetary action.

And as the summer swoons on, it looks less and less likely that there is anything that will finally get us back to full employment. For now, rates are still near historic lows, and the equity markets, after using the Bernanke talking points as an opportunity to take profits, now seems to be focusing attention elsewhere.

Stocks have also been higher again. Maybe it is hope for a stronger earnings reporting season, which kicked off this afternoon with Alcoa reporting a $119 million loss, compared to a loss of $2 million a year ago. Alcoa posted big expenses for restructuring and legal costs. Woo hoo, happy days.

The analysts who analyze earnings seem to live in a mystical land of make believe. Six months ago, they predicted 2Q earnings growth of 8.7%; they've cut that to 1.8%: but they still think S&P 500 index share prices will rise by 8.8%. Getting to their price target would raise the index’s earnings multiple to 16.4; that's not a historically high multiple, but it might not reflect the anticipated slog. After three years of growth, earnings increases are slowing. Income in the S&P 500 advanced an average of 4.3 percent in each of the last five quarters, compared to the 28 percent average for 2010 and 2011.

Also, as we work our way through earnings season and look at the broader economy, GDP has been revised lower; down from 2.2% in 2012 to an estimated 1.9% this year. Data will likely be overhauled at the end of the month, and the expectation is that it will be revised lower. So, earnings growth alone is apparently not enough to reach escape velocity. The International Monetary Fund will probably lower its global growth forecast for the remainder of the year; they already lowered their forecast from the start of the year, down to 3.3% from an earlier estimate of 3.5%. They say they are seeing weakness in emerging countries in particular.

So the bar keeps getting lowered and nothing recedes like progress.

Oil prices moved slightly lower today, but remain entrenched in triple digit territory. Part of that is a risk premium associated with Egypt. At least 51 people were killed when the Egyptian army opened fire on supporters of ousted president Mohamed Mursi, in the deadliest incident since the elected Islamist leader was toppled by the military five days ago. Hundreds more were wounded today.

The Egyptian military has insisted that the overthrow was not a coup, and that it was enforcing the "will of the people" after millions took to the streets on June 30 to call for Mursi's resignation. The US government isn't calling it a coup because that would mean an end to $1.3 billion a year from Washington. That is called aid, but it also serves to pay Egypt to keep the peace with Israel. Apparently, a military coup by any other name is better than a democratically elected Muslim Brotherhood. So, the whole democracy thing is very messy, but the oil is still being transported through the Suez Canal.

The same cannot be said for oil being transported by rail in Canada.

Canadian police are still looking for the remains of people killed when a driverless crude oil train derailed and blew up in a small Quebec town over the weekend. The five locomotives and 72 oil cars had been parked near the town of Lac-Megantic in Quebec; that's not far from Maine. The brakes then somehow released and the train gathered pace as it rolled down a hill into the center of the town early on Saturday morning. It derailed and exploded into a gigantic fireball, flattening dozens of buildings and killing five people. Another 40 are missing and few residents hold out hope that they will be found alive.

Canada's railways have made a determined push to cash in on the country's crude-oil bonanza, painting themselves as a cost-effective alternative to politically unpopular pipelines like the proposed Keystone XL. The Canadian Railway Association recently estimated that as many as 140,000 carloads of crude oil are expected to rattle over the nation's tracks this year, up from only 500 carloads in 2009. That represents a 28,000 per cent increase in the amount of oil shipped by rail in the past 5 years. The Quebec disaster is the fourth freight-train accident under investigation involving crude-oil shipments since the beginning of the year.

So, there are some concerns about the ability to ship oil, whether on rail in Canada or by way of the Suez Canal; still, the recent run-up in oil prices is disconcerting. We've seen a big sell-off in commodities ranging from gold, to industrial metals, iron ore, extending to grains, natural gas and on. We've seen strength in the dollar, which was always a good excuse from the energy experts to explain falling oil prices.. We've seen demand for oil falling. Demand is dropping in China as that economy slows; the IMF is projecting slower and slower global economic growth, and that should mean less and less global demand for oil. Americans are driving less and less, not more and more; and we're driving more efficient cars. There has been a record jump in US domestic oil production, which has grown by more than one million barrels per day over the last year; that's the fastest growth in production in decades.

Some 5 percent of seaborne crude oil passes through the Suez Canal. Not inconsiderable, but its potential cost can be clearly calculated. The closure of Suez would not stop the lifting and shipping of oil cargoes. It would however add approximately 16 days steaming time around Cape Horn to an oil cargo's sea voyage otherwise precluded from using the canal, and the added expense works out to less than 50 cents a barrel.

To fully appreciate the excesses of the oil market one needs to understand that some 80 percent of all contracts bought and sold on the commodity exchanges are not executed by actual producers or crude oil consumers engaged in 'legitimate' hedging strategies, but rather by speculators and gamblers trying to drive oil prices in the direction in which they have placed their bets.

The Commodity Futures Trading Commission (CFTC) was given the authority by virtue of a January 2010 rider to the Commodity Exchange Act, to implement speculative position limits for futures and option contracts of certain energy commodities such as crude oil. To date, no action has been taken by the CFTC other than interminable hearings which one can well imagine have become a cover for the total lack of meaningful process.

In April 2011 the president amidst great fanfare, focused on 'speculation' in the oil market, giving Attorney General Eric Holder a mandate to investigate and announcing the formation of 'The Oil and Gas Price Fraud Working Group.' To date, more than two years later, not a word has been heard from this august commission.

A couple of weeks ago the Federal Trade Commission opened a formal investigation into how prices of crude oil and petroleum-derived products are set, mirroring a European Union inquiry. The investigation, now in a preliminary stage, will probably broaden into a multi-jurisdictional affair like the inquiry into manipulation of the London interbank offered rate, or Libor.

The price of oil is actually set, much like the Libor rates, by a data and news service called Platts. Platts publishes the Dated Brent benchmark that contributes to setting the price of more than half the world’s oil. The EU oil probe, which extends to undisclosed crude-derived products and biofuels, underscores how pricing in some energy markets lacks the transparency of financial products such as stocks and US corporate bonds. It also marks the third time global pricing benchmarks have drawn the regulators’ scrutiny in the past year following investigations into bank manipulation of the Libor, and ISDAFix, the benchmark for the $379 trillion swaps market.

In other words, everything is rigged. 

Monday, May 20, 2013 - Daily Scandals and Distractions

Daily Scandals and Distractions

by Sinclair Noe

DOW – 19 = 15,335
SPX – 1 = 1666
NAS – 2 = 3496
10 YR YLD + .02 = 1.96%
OIL + .58 = 96.87
GOLD + 33.90 = 1395.10
SILV + .66 = 23.02

I suppose we should start with the scandal du jour, since this is where most of the news has been fixated recently. I'll try to focus on how it affects the economy and the markets, but it's hard to ignore the bluster. One quote I heard over the weekend was "add Watergate and Iran Contra together and multiply by ten" to calculate the tyrannical evil of the Obama scandals.

Actually, the current scandals are not even close (I'm old enough to remember the enemies list and plumbers). I don't think the scandals are inconsequential but I think some historical perspective might help. The rhetoric without perspective might actually backfire. But what we concern ourselves with here is the economic and financial impact. And it's likely there will be limited economic impact. We've seen worse, and the markets survived and sometimes even prospered.

Remember Iran Contra? It happened to coincide with one of the greatest bull runs the market has ever seen. And remember the Lewinsky scandal? It coincided with a market that was described as irrationally exuberant; this is often attributed to gridlock in Washington, or some sort of moderation. Actually, the old idea of gridlock being good for markets, doesn't really hold water.

When one party controls both the White House and Congress – Republicans or Democrats – the markets perform about 5 times better than when the president and Congress are from opposite parties. It doesn't seem to matter for the current administration; the market is enjoying big gains, with the S&P 500 up 149% since the lows of March 2009. And when things look bad, the market goes higher.

The explanation may come from the Federal Reserve. Weak numbers on any front are viewed as a sign that the Fed will remain accommodative as will other central banks around the world. The old adage "don't fight the fed" has really become "don't fight the feds' - as in plural. Trillions of dollars on the sidelines have to be put to work and are hungry for yield, especially from stocks. 

The trillions of dollars worth of central banks stimulus has put into play the past few years have socialized risk. The game used to be private gains and private losses. Now it's private gains and socialized losses. Businesses that have under-invested for years are beginning to capitalize on a distracted Washington using the breathing room to make new investments.

Anyway, the markets appear to be propped up, for now at least.

Remember the Libor rate rigging scandal? Several of the biggest banks were rigging Libor, the interest rate that is used worldwide for just about everything. When the Libor Scandal broke it raised the question, what else is rigged? We learned that derivatives, specifically the nearly $400 trillion dollar market in interest rate swap prices were subject to possible manipulation of the ISDA fix.

The latest revelation is oil price rigging. A review ordered by the British government last year in the wake of the Libor revelations cited “clear” parallels between the work of the oil-price-reporting agencies and Libor.

They are both widely used benchmarks that are compiled by private organizations and that are subject to minimal regulation and oversight by regulatory authorities. To that extent they are also likely to be vulnerable to similar issues with regards to the motivation and opportunity for manipulation and distortion.

Last week, the European Commission raided the offices of Shell, BP and Norway’s Statoil as part of an investigation into suspected attempts to manipulate global oil prices spanning more than a decade. None of the companies have been accused of wrongdoing, but the controversy has brought back memories of the Libor rate-rigging scandal.

The inquiry also involves Platts, the world's largest oil price reporting agency. Europeans have long complained that retail gas prices have not seemed to match wholesale prices. In fact, complaints that retail prices at gas stations were noticeably slow to fall when wholesale prices fell prompted the U.K.-based Office of Fair Trading last year to conduct a cursory inquiry into possible anti-competitive behavior in the fuel markets.Early this year, they announced that they hadn't found enough evidence to warrant a full-blown investigation. But complaints persisted.

Reuters points out that the probe may be expanding to the U.S.:

“In Washington, the chairman of the Senate energy committee asked the Justice Department to investigate whether alleged price manipulation has boosted fuel prices for U.S. consumers.

“Efforts to manipulate the European oil indices, if proven, may have already impacted U.S. consumers and businesses, because of the interrelationships among world oil markets and hedging practices,” Sen. Ron Wyden (D-Ore.), chairman of the Senate Energy and Natural Resources Committee, wrote in a letter to Attorney General Eric H. Holder Jr. Wyden also asked Justice to investigate whether oil market manipulation was taking place in the United States.”

Not only are petroleum products a multi-trillion dollar market on their own, but manipulation of petroleum prices would effect virtually every market in the world.

There's a lot riding on the price of oil, including how much money OPEC nations need to keep their governments funded. At $100 a barrel, there's enough profit to produce the oil and to fund the governments. Things get dicey around $80 a barrel; $60 dollar a barrel oil spells big problems for almost all OPEC countries.

Meanwhile, the International Energy Agency (IEA) in its Oil Market Report claimed that America's shale boom is growing even larger than expected. It's also set to have a profound effect on OPEC. OPEC is also set to produce, or have the capability to produce, a lot more oil. One main driver of that supply growth is Iraq. After a turmoil-filled decade, Iraq is coming back on line in a big way -- and could add another 3 million barrels per day to the oil mix by 2018.

So the U.S. has lots of oil, and we're producing it at an ever-growing rate. And OPEC has a lot of oil and is either producing it or sitting on it.

And what's funny is that if OPEC continues to cut supply via quotas, all it will do is help the U.S. oil boom. They'll essentially be crimping supply to boost prices... and we'll benefit. So why are prices still high? Central banks are still printing money. The Fed and the BOJ are printing away, and it's probably only a matter of time before the ECB joins in. Maybe that explains something. Then there is the fear premium. Then there is the idea that prices are rigged. Nobody wants to upset the situation, at least not right now.

The Saudis aren't happy that Iraq is coming online with about 3 million barrels a day by 2018. This could lead to a round of infighting among OPEC -- with each nation trying to eke out the most money. Frankly, the Saudis have massive incentive to see Iraq fail. The same goes for Iran. There are sanctions against Iranian oil, and that has as much to do with the price of oil as any specific act of craziness from the Iranian crazies.

The U.S. and OPEC are set to produce much more oil. And even though US and Euro demand is falling, demand from the oil-thirsty East is set to ramp up. So, we have an uneasy equilibrium in the oil markets right now.

The Federal Reserve Bank of San Francisco points out: When gasoline prices increase, a larger share of households’ budgets is likely to be spent on it, which leaves less to spend on other goods and services. The same goes for businesses whose goods must be shipped from place to place or that use fuel as a major input (such as the airline industry). Higher oil prices tend to make production more expensive for businesses, just as they make it more expensive for households to do the things they normally do.

Oil prices indirectly affect costs such as transportation, manufacturing, and heating. The increase in these costs can in turn affect the prices of a variety of goods and services, as producers may pass production costs on to consumers. Oil price increases are generally thought to increase inflation and reduce economic growth.

Oil price increases can also stifle the growth of the economy through their effect on the supply and demand for goods other than oil. Increases in oil prices can depress the supply of other goods because they increase the costs of producing them. In economics terminology, high oil prices can shift up the supply curve for the goods and services for which oil is an input. One major area that could feel the pinch is agriculture, and the prices of the food we eat.

There are some important scandals, just don't get distracted.