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Oil
Takes The Dive
After
being stopped out of the short side of crude twice, the market finally
crashed as I had anticipated. Once again, volatility proves that even when you’re right,
your trading can fail to yield a profit.
The significance of oil’s plunge is far reaching when
considering how intricately this commodity is tied into the Middle East
and our own economic health. Cheaper
energy was the catalyst we were seeking to stimulate the economy before
the demise of the World Trade Center.
Regardless of Federal Reserve rhetoric about the diminished role
of energy prices in our gross domestic product (GDP), there was
absolutely no doubt that back-to-back years of excruciating energy bills
took a toll on the American and European public. Let’s face it… we
just went through a serious energy crisis that brought California to its
fiscal knees and threatened other major population centers.
An
entire segment of the Bush/Gore debate centered on developing an energy
policy and creating “energy independence.”
This brings up a very interesting theory about the timing of
recent terrorism. Stories
about terrorist motives have appeared on virtually every news station
and throughout newspapers since the horrific incident of Tuesday,
September 11th. What
becomes clear is the confusion over motives.
Regardless of apparent anti-American sentiment, the Middle East
has a powerful symbiotic relationship with the West.
America, Europe, and Japan are the economic lifeblood of OPEC.
The Saudi Prince, while deeply religious, drives a Rolls Royce
and a Ferrari. He boasts
one of the largest private yachts in the world.
Most of the Royal Saudi family wealth is invested in Western
companies, government bonds, and real estate.
Thus, Bin Laden is a contradiction to the entire lifestyle of
modern Islam.
However,
there has been mounting tension between OPEC and the industrialized West
because each side has an apparent strangle hold on the other.
We need OPEC oil… for
now. OPEC needs our money.
However, the latest squeeze OPEC inflicted was met with
significant hostility. Effectively,
OPEC went too far. As if
they had their own death wish, OPEC contributed to the decline in
Western economies and helped destroy their own wealth as U.S., Japanese,
and European stock markets faltered.
By some private estimates, OPEC lost more money in deteriorating
investment value than they achieved by raising oil prices.
They helped to create an energy crisis that clearly backfired.
In
addition, OPEC became “politically incorrect.”
This is to say that there was a strong U.S. backlash that
reverberated in Washington. America
was about to take serious action. This
threat of energy independence can be viewed as retaliation…
it is a form of war. Just
we were developing anti-OPEC sentiment in the United States, it is not
hard to reverse perspectives to see how Middle East oil producers were
evolving growing anti-West sentiment.
This gave radical Islamic Fundamentalists a brief foothold.
Terrorist sympathizers were content to keep the illusion of
conflict simmering with the Arab – Israeli discord.
In their wildest dreams, they never imagined an all-out attack on
the United States of the magnitude we have seen.
Now, everyone is in trouble.
Unquestionably,
the United States and its allies have the capability of reshaping the
map. All the nonsense about
how difficult it will be to fight a war in Afghanistan is simply war
machine public relations. Operation
Desert Storm is not the objective.
We need a prolonged action to reestablish the U.S. military
industrial complex. The reality is that we have the weapons and skill to
annihilate Afghanistan and any other hostile nation.
But, such a “quick solution” is not acceptable at this
time for economic and political reasons.
However, any further terrorist attacks could be the catalysts for
unimaginable retaliation. Indeed,
a new global war is not far from reality.
OPEC
is keenly aware of this possibility.
As I mentioned, they have the impetus to pump like crazy to
support the West in its quest to regain economic stability and
reestablish the money flow to OPEC producers.
Moderate OPEC nations cannot afford a Holy War.
Most assuredly, the West would usurp Iraq, Iran, and a host of
other oil-rich countries if a war escalates.
Once in control of “swing production,”
the West would exercise substantial control over world oil
production and pricing. This
event would probably turn the rest of OPEC against the West in one final
conflict. Under such
circumstances, Islam would be torn between fundamentalism, politics, and
survival. Non-OPEC nations
like Egypt, Jordan, Syria and Lebanon would face serious alliance
issues. With whom do they
side? Any rational
government is not going to declare war against NATO.
For
speculators, the immediate opportunity is in the short side of energy.
OPEC intends to please the West with lower prices.
Obviously, the first bombs to drop will jerk oil up and down, but
I believe the general direction is down.
Further, the supply side is not the only driving force.
A huge drop in jet fuel demand coupled with a near stoppage in
U.S. travel has literally halted product demand.
In a near instant, natural gas has plunged from $10 to $2.
December
crude oil above demonstrates how prices can literally “fall off the
map.” Yet, we
should keep in mind that crude oil had more impressive declines in 1985
and 1990 as the following monthly chart indicates.
From a high of approximately $30 in October, 1985 prices nose
dived to $9.75 by April. Immediately
following Dessert Storm, process plummeted from $40 to $17.50.
The
speed of these “corrections” is truly remarkable.
Circumstances are very similar to our current situation.
However, the next several weeks will carry more uncertainty.
Understand that the 1985 decline was due to a disagreement
between OPEC members about quotas. That was a supply-driven event.
Obviously, 1990 was a conflict-driven phenomenon. The speed of
the military intervention was unprecedented as was the swift return of
Kuwait’s oil to the market.
We
should be aware that the World Trade Center destruction took down the
entire U.S. psychology. People
are not flying… not
driving… not buying. The
shock will take months to overcome.
I would not be surprised to see a dramatic shift in energy
consumption that adds to the current weakness.
A recession would impact transportation to the point where crude
could, once again, penetrate below $10.
Precious Metals
There
has been considerable talk about the pros and cons of gold and silver.
I turned bullish on gold based upon the “fear factor.”
The current environment draws a very fine line between a bullish
or bearish scenario. If
commodity prices are due to implode from the new “recession,” then
there is no reason why gold should offer upside potential.
On the other hand, massive monetary expansion can decrease
confidence in paper assets. If
all else fails, move into gold. With
prices remaining a hint under $300 an ounce, the downside is viewed as
limited. After all, gold is
not likely to become totally worthless.
The question is, “How low can gold go?”
The daily chart suggests $265 as an approximate floor.
We have to go back to January, 1979 to find prices as depressed
as we have seen over the past two years.
It is difficult to buy gold in the face of collapsing oil… among other
raw commodities. Yet, until
the war on terrorism takes a more definitive track, uncertainty is
likely to support the yellow metal.
Silver
also represents a flight to quality.
While I have been more skeptical about silver’s potential than
gold’s, I cannot overlook silver’s role as the “poor man’s
gold.” Silver is more
affordable. Despite
continuing strides in digital imaging, silver could experience an
extraordinary demand surge as tension and uncertainty mounts.
In some ways, silver’s chart is more attractive with a more
defined “pennant.” The “pole” is crystal clear.
Although the flag is shallow, it is apparent. A breakout above 46500 penetrates the upside and sets the
stage for a rally as high as $5!
Debt
Markets Fear Oil’s Decline
As
earlier alluded to in this REPORT, oil producers are bound for declining
revenues as prices slide. Countries
like Russia, Venezuela, Nigeria, and Mexico rely upon oil as a major
component of foreign revenue and a means to finance through debt.
Already,
newswires carry stories about questionable debt repayments and possible
defaults. Russia’s Energy
Minister, Igor Yusufov, has indicated that Russia is not concerned and
he views the price decline as temporary.
Russia was invited into OPEC, but chose to be an “observer.”
This allows Russia to coordinate with OPEC without being bound by
quotas and rules.
In
truth, the world has been building overcapacity.
Saudi Arabia has more than doubled pumping capacity over the last
four years as have other OPEC countries.
Russia has been rapidly developing new fields while using Western
funding to revitalize old wells. My
sources tell me Russia is ready, willing, and able to participate in a
price war with an average cost-per-barrel under $5.
Russia controls the largest oil reserves on the planet.
In reality, OPEC represents a competitor rather than an ally. Surely, Russian bonds have a high degree of risk.
While I don’t recommend them, I am not as skeptical about their
potential.
Meanwhile,
traders have finally picked up on U.S. long bonds as a “quality
issue.” I believe the yield curve is too aggressively skewed toward
the long end. The 30-year
and 10-year rates should decline to flatten the curve.
We have indication the FED will continue easing the short end.
At some stage, I think investors are going to consider bonds
fairly cheap. After all, a
nominal positive return is better than negative stock market
performance!
Here,
again, I attempted to buy during a “bull market correction.”
Recall my chart comments when I recommended the buy last week:
“December Bonds display a substantially bearish picture.
By any technical standard, they are a sell.
However, the stock market close suggests bonds may be the only
place to flee besides gold. The
word is that investors fear Bonds will lose parity against the Euro and
lose foreign participation. We
are going contrary to the chart… for now.
Heaven help us!”
Well,
so far heaven has been on our side.
This demonstrates that chart analysis is an art more than a
science. Sometimes,
fundamentals play the pivotal role in being right….
Sometimes!
With
the S & P 500 looking like the chart above, who wouldn’t want a
little “quality” in their portfolio?u
Email:
phil@commodex.com
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