|
Energy
Reflects Economy
The
latest API figures reflected the first decline on petroleum demand in
ten years and set the stage for a renewed battle between OPEC quotas and
general economic malaise. This was exactly what I had predicted on
my previous attempts at selling crude for a test below $18.00.
Unfortunately, the test couldn’t materialize when I was picking
entries. Last week, the price appeared to be settling into a
trading range between $19.50 and $18.04. With the 20-day and
40-day averages converging, it seemed we would be safe selling the
option strangle through the February delivery.
Although
consumption figures suggest there is further downside potential, prices
have not declined precipitously, yet. For the moment, February
crude continues to find support at $18. With 75 points in premium,
the strangle was safe between $22.25 and $18.75. Options expired
today, leaving us long from $19.50. This obviously requires
defensive action since February crude is trading at $18.78. Even
if we cover at breakeven, it proves the efficacy of short strangles when
volatility generates sufficient premium and the time to expiration is
short. We may eek out 2¢ to cover costs and look for the next
opportunity.
A
glance at the current chart still appears technically suspicious.
First, we see the support generated at $18. Then, we should
consider the downward slope of the current “flag.” Generally,
continuation flags appear in the opposite direction of the trend.
This
provides a basis for a pop higher before February futures expire.
Despite the bust below the moving averages, crude still displays the
characteristics of a trading range market.
Fundamentally,
I still believe OPEC cannot sustain quotas when the world is caught in a
mounting recession. Finally, consumption figures reflect
this reality. Middle East tension is isolated to Israel and the
Palestinians for the moment. All indications are that this
isolation will continue since the voice of Bin Laden has been silenced
and he was the only vocal agitator hoping to expand the conflict beyond
the local Israeli borders. This means “business as usual” for
OPEC producers.
Adding
to this mix is the U.S. Enron situation. I have confidence that
investigations will show Enron manipulated natural gas prices to their
unholy highs last year. The jockeying of natural gas values
against #2 oil has resulted in burners capable of switching from liquid
to gas and back again. With Enron’s speculative influence
neutralized, natural gas has normalized and is, once again, the
efficient fuel of choice in the Midwest and West. The drop in
distillate demand has begun to erode crude’s former dominance.
Strategically,
OPEC must chose between trying to maintain prices or volume. My
research reveals some interesting developments that are likely to cause
OPEC considerable angst over the next several years. For example,
Azerbaijan has embarked on a capital improvement program that was slated
to increase capacity by approximately 160,000 barrels per day over the
next two years. The latest indications imply this region will
achieve more than twice that level by 2003. Chad is also ahead of
the curve with an estimate of increased output that will exceed 200,000
barrels per day by 2003/4. Russia, alone, has the ability to boost
output by 1.27 to 2 million daily barrels. Recent negotiations in
Kazakhstan are likely to provide more than $2.5 billion in Western
financing to take last year’s estimate of an 880,000 barrel per day
increase all the way to 1.6 million… almost double. (original
estimates of Deutsche Bank; Petroleum Argus)
The
fact is that OPEC faces an emerging non-OPEC capacity glut that is
coming on stream faster than anyone anticipated. This is clear
when reviewing strategic reports produced as recently as third quarter
2001! Consider that there have been additional discoveries in
Canada, Brazil, Angola, Mexico, and China. All of this capacity
comes at a time when technology has the ability to curb consumption by
25% to 35%. The bitter after taste Americans endure from the
2000/2001 energy price spike has taken a toll on the Mega-Vehicles
Detroit released for the presumed height in SUV demand. Behemoths
like the Ford Excursion and GM Yukon SLX are being traded for thriftier
Subaru Outbacks and the like. The gas-guzzlers have definitely
taken a hit as have all new car sales. Rhetoric over more
terrorist attacks and an OPEC shutdown has spooked the U.S. public to
the point where purchasing decisions may become defensive. Price
is not the only objective. Having a car that can run the extra
miles is becoming a priority.
As
Bill O’Reilly of Fox News reiterates, Detroit is capable of producing
a 70mpg vehicle. This, alone, would make the U.S. energy
self-sufficient. Clearly, Bill is not politically correct in the
real sense of the phrase. Washington’s links to both Detroit and
West Texas are mighty powerful. Politically, auto-makers and oil
producers are the “correct” path for the Administration and
Congress. Witness how carefully Congress is handling Enron.
Although the Democrats would clearly like to blow this up into a
Presidential or Vice Presidential scandal, too many of their party were
receiving Enron favors. This mess will be appropriately buried
without a funeral.
No
one ever expected to see $10 natural gas. Few expect to see $10
crude. However, nothing is beyond the realm of possibility.
Attention is called to 1985 when oil crashed from $30/bbl. to less than
$10 from October 1985 to April 1986. With a historical precedent
for 50% price swings in six months, we should not be surprised if crude
busts the $17.25 level to see equilibrium below the teens. Even
behind OPEC’s doors there is a debate over the price/volume formula.
OPEC’s global investment values have been severely diminished by stock
market declines and low interest rates. Does it pay to contribute
to a prolonged world recession by boosting oil prices?
Even
gasoline has come under pressure to the extent that the 3-pronged
trendline established from the November low has been penetrated.
The 40-day has crossed under the 20-day. Weather has actually
prevented ski-related travel in the Northeast. Overall, Americans
are, indeed, staying more at home.
“As
the days begin to lengthen, the cold begins to strengthen,” so the
saying goes. This year has been unusually mild with some
record-breaking temperatures across the northern tiers and consistently
mild conditions along the eastern corridor. The winter is young,
but February is the transition month when refinery formulation ratios
are adjusted to begin building gasoline inventories over heating oil.
The gasoline/heating oil spread is reasonably narrow to suggest traders
have already taken this into consideration. Absent a cold snap,
the spread may offer a few cents. The products appear favorably
priced relative to crude.
Meats
It
appeared we would be stopped out of our short February live cattle as
prices edged toward 7177. However, we moved our stop to entry
after reaching the 6987 objective. Since February is close to
expiration, we would have been forced to roll if the stop had not been
touched. Tomorrow’s report is expected to reveal a drop in
placements that has already been discounted. I have heard weights
are up as a result of milder temperatures. One can cancel the
other.
With
recession fears sparked by this week’s stock market weakness, families
are supposed to cut back on more expensive red meat in favor of poultry
and pasta. I have not had an opportunity to review retail sales to the
extent that this theory can be confirmed or refuted. There is a
correlation between the economy and higher priced food consumption.
However, this is not going to influence prices as much as the supply
side (for the moment).
Technically,
February cattle demonstrates resistance between 7150 and 7200. The
uptrend remains in place with a potential violation requiring a decline
to 6950. I “feel” bearish, but the chart refuses to confirm my
convictions. This forces me to wait for a more definitive
technical signal.
In
the meantime, lean hogs have been pushing upward despite my assertion
that there are plenty of pigs being fattened for market. My
assessment of this has been wrong and our avoidance of a position seems
appropriate. I’d rather be out, wishing I was correctly in than
incorrectly in, wishing I had never made the trade. If resistance
appears near 6200 in April lean hogs, I would expect a 4¢ correction.
I am not inclined to join the bulls.
Equities
There
was considerable jubilation when the DOW cracked 10,000 and seemed to
have regenerated confidence and strength. I receive at least a
dozen cold calls (yes, I get them, too) touting the end of the bear
market and the beginning of a new “buying opportunity.” The
latest return to four digits has created a new wave of despair for those
who, once again, listened to the cold callers or their traditional
brokers.
The
latest telling victim was not Enron, but Kmart. The giant and,
once infallible retailer has come under the same pressure that put
venerable Caldors out of business. This is the heartbeat of
America and it isn’t sounding very good. A consolidation of
discounted retail signals a change in consumer spending. In short,
these outlets failed to move inventory at the pace required by the
“low-end” model. Although some analysts claim Kmart lost its
focus when it attempted to upgrade with Martha Stewart, numbers don’t
lie. All of retail took it on the chin this season and it is not
improving. The bad news is not over until it’s over. Ford,
GM, Daimler- Chrysler, and related suppliers are suffering from
overcapacity and poor sales. The layoffs and factory shutdowns are
just beginning.
The
DOW’s recovery slowed to a consolidation range between 9800 and
10,300. The bust below 10,000 correlated with the 40-day average
to make it particularly disappointing. Some technicians believe
this is a required beginning of a 50% retracement from 10,300 to 9200.
From there, the market should resume its uptrend beyond 11,350 made in
May of last year.
I
am not as optimistic. It is doubtful corporate America will turn
around in the next six months. Lacking earnings, dividend
performance will be dismal and analysts will be forced to reevaluate
valuation models. The complete evaporation of earnings places P/E
ratios in the range of simply “P” rations. There are no Es!
This means that any multiples formula is distorted for such entities.
Unfortunately,
a good case can be made for a test of 7000 before strength returns.
Even more unfortunate is the prediction that such a test will plunge the
economy into the abyss… a new movie, perhaps!
Email:
Phil@commodex.com
|
