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Energy
Prospects
As
gasoline prices fall and consumers face less daunting heating oil or
natural gas bills this winter, there is a glimmer of hope that some
forces that plunged us into a recession may reverse through 2001 and
2002. As is constantly mentioned by FED watchers and economists,
consumer spending is a function of “disposable income.” As one
subscriber told me, “My wife can dispose of my income quite well,
thank you!” On the other hand, many a wife has called me to ask
why their husbands insist upon committing financial suicide.
Seriously,
my SPECIAL REPORTS of last year emphasized the role higher energy prices
could have on the economy. Well before September 11th, the
substitution of fuel for discretionary spending seemed obvious.
Putting it into perspective, a 10-gallon tank at an average of $1.77 per
gallon equals $17.70 while the 25-gallon Jeep climbs to $44.25.
The average commute has risen to 12.5 miles each way with fleet mileage
hovering at 17mpg. Of course, these statistics are all over the
place. Assume the average burn is 2 gallons per day to make it
simple. That’s $3.25 per day times a 23-day work month, or
$81.42. This number rises to $200 for the big cars and big
commutes and drops to $25 for around-town drivers.
The
point is that a 50¢ drop in price is that extra $1 per day.
Multiply that by the 100 million drivers and the economy swings by $100
million a day. When you consider the impact of this and the plunge
in natural gas from $10 to $2.60… not to mention heating oil’s drop
from 86¢ to 62¢, it is not difficult to understand how the consumer
economy can get a boost from the recent correction. Consider that
the move up was approximately 18 months. While I don’t suggest
energy was solely responsible for the recession, I do imply that
economists and the FED took spiraling energy cost too lightly.
For
example, the “stimulus package” offered by the Democrats and
Republicans falls somewhere between $80 and $120 billion. Compare
this to $100 million per day times a 255 day work year which is $25.5
billion… roughly 1/4th of the tax package. Add other
energy savings in heating, air conditioning, and lighting to arrive at
another $25 to $35 billion! These are big numbers… but,
there’s more. Crude oil is the feedstock for chemicals,
plastics, and fertilizer. As the major price component, a
plunge from $30 to $20 cuts raw material costs by 33%.
The
question is, “Is it enough?” Unfortunately, the answer is,
“No.” The downward economic spiral is already seriously in
place. Unless the new military initiative can absorb all the
displaced private sector labor, we are in for rough times. Just as
the economic boom lasted longer than the historical norm, so might the
economic doldrums. Interestingly, OPEC is caught up in their own
folly… just as I predicted more than a year ago. Some
subscribers should recall my subject of OPEC’s “Last Hurrah.”
I pointed out that any sustained effort to prop prices higher than
justified by demand would be self-destructive. Indeed, OPEC
members lost more value in their overseas investments than they gained
in additional oil revenues!
There
was an effort to hold crude between $25 and $27 dollars per the chart.
OPEC was targeting $22 to $27. But, the economic slowdown got in
the way before September 11th took hold. Except for the knee-jerk
spike, a combination of reduced aviation consumption, the slowdown,
increased use of public transportation, and OPEC resolve to cooperate
took oil to contract lows.
Admittedly,
I tried to participate in several short sales where stop protection was
too conservative. On the other hand, how bold can a prognosticator
be with other people’s money? I interpreted the post spike
consolidation between 22.25 and 23.75 as a “continuation flag”
seeking a test below $20. That hasn’t happened and the newly
formed “V” with its double-pronged bottom is cause for concern.
However, there is a good chance resistance will hold at 22.50 in the
December contract. Of course, a spread of the conflict toward oil
producers could immediately alter perception.
Earlier
this week, The New York Times published a story about Russia’s oil
potential and, in particular, Kazakhstan. We haven’t heard much
about Kazakhstan when considering this Russian State holds the world’s
largest crude reserves. I’ve been making noise about Kazakhstan
and its neighbors since the fall of the Berlin Wall. I know
that’s a bit too long a perspective for a commodity analyst who looks
for weekly profit opportunities.
The
article published a table of projected increases in oil production
between 2000 and 2005 for non-OPEC and OPEC members. In my
estimate, the numbers are highly conservative. Russia’s current
output is just under 7 million barrels per day. Over the next five
years, the article calls for a 1.27 million barrel per day increase.
I see that number as high as 3 million. Kazakhstan is producing
7/10ths of a million barrels per day with a forecast of another 9/10ths.
I would not be surprised to see 1.3 million barrels within the next two
to three years.
All
of this “new” production is on top of existing OPEC and non-OPEC
output. Furthermore, the Caspian Basin has a low average
extraction cost. Profitability comes in below $10 per barrel after
capital equipment and development costs on a 20-year straight-line
amortization. Don’t forget, that’s according to our accounting
methods!
We
have taken a more aggressive short stance by seeking a bust below $20
before moving our stop to entry. I was debating whether the option
strangles made sense based upon a potential consolidation pattern that
could last through the November expiration. Although we are
risking a loss if crude reverses, we need enough room to accommodate
sharp rallies and the formation we are currently seeing. If 22.50
holds, we may wait a while for a bust, but our risks will be diminished.
Technically,
a consolidation of more than three weeks would be a warning to move our
stop to entry before support is broken. This is because we run a
danger of a spike if the 20-day and 40-day averages converge and other
traders are looking for an upside breach of 22.50. Overall, this
could get very exciting. A probe below 19.71 sets up a dramatic
secular trend that could eventually test $16. What’s
“eventually?” Before spring!
Depression?
With
grains, cotton, copper, coffee, and a host of other raw commodity prices
touching multi-decade lows, talk of a “commodity depression” is
beginning to surface. Last week’s SPECIAL REPORT spooked many
subscribers who were unaware of our exposure to food supply disruptions.
One subscriber emailed me with an angry reaction that I was like all the
other media idiots that are “busy volunteering how to terrorize our
country.” I half agree that we should not be pointing the
Taliban in the right direction. But, I reviewed my subscription
list and am happy to report that I don’t have any suspicious looking
customers.
My
point was to call attention to the double-edged reaction a livestock
epidemic or pandemic could have upon prices. Any hint that U.S.
beef supplies were being targeted would probably plunge prices well
below production… even with cheap grain and low interest rates.
Traders should be prepared.
The
USDA livestock assessment shows slower growth and the potential for a
rally based upon last year’s consumption patterns. However, we
are not dealing with last year’s demand.
The
chart has a remarkable resemblance to crude oil. Of course, the
fundamentals are substantially different. We remained short feeder
and live cattle despite my nervousness over the first downward sloping
flag that had the potential for being a reversal pattern. I was
aware that reports might also be supportive. Yet, my retail
sources suggested sluggish movement and the lack of animals was
compensated by higher weights. Keep in mind that the contract is
in pounds, not number of animals. I’m afraid a bust below 6600
will carry to 6200. From there, I see stability unless we have a
scare.
I
was sorry I missed lean hogs that dropped like a stone to test below
5000. However, we took the hog/belly spread at 27¢ and it has
come in to approximately 1650. I did not want to offset the short
lean hog leg. In retrospect, it would have been best to be short
both. But, the return on spread margin is actually better.
Yesterday,
at least six of my farmer friends called to ask whether there was any
encouragement from slight strength
in
beans, wheat, and corn. With the harvest just about done, weather
is no longer a factor. The elevators tell me they are surprised at
the size and quality of corn and beans. Even the seed producers
are shocked at the resilience of new “blends.” Genetically
altered grain is not politically correct. I’ve heard of coffee
blends… but, seed?
There
is a possibly strength in January beans could fill the massive gap.
In addition, prices found support at the previous set of bottoms made in
May and June. We are short with a new stop at 4.39½, having made
our 4.27 objective. I’m inclined to put a buy in at 4.43½
looking for a pop to 4.50. It’s risky, but look at that gap!
Cotton
is another commodity that is revisiting 30-year lows. There’s
really nothing to draw on the daily chart. The picture speaks for
itself. One thing is for sure. Given the inputs required for
cotton, the farmers aren’t making any money this season. I
don’t see a lot of planting next season unless we see a 20¢ recovery.
Even that would be tight.
A
chart like this is a traders dream. Foolish me. I was trying
to buy the July breakout. Once again, I was caught by the
question, “How low can it go?” Answer… “Lower than
it is now!”
However,
there is some efficacy in placing a buy stop around 3160. I
believe a rally above this small resistance level could produce follow
through. The 20-day and 40-day are substantially above the market.
If we do not see a voluntary lift from this bottom, these averages will
quickly converge on the price to produce potential technical chop.
This brings me to fundamentals.
The
media seems to be talking up consumer spending. Hey, the malls are
filling up. Sales are higher than last year… we think.
When news seems unreliable, go to the source. Pre-season apparel
orders stink. There’s no other word for it. My
investigation shows cancellations from China to India. U.S. mill
orders are down and a dismal picture appears for cotton. The
strong Dollar makes U.S. cotton more expensive. Under current
circumstances, 2000 crop cotton could sink to a quarter.
Simply
put, growing for 25¢ is unaffordable. If depressed prices
persist, I’m a buyer of July and October 2002. At $500 per
penny, even a dime suits me fine!
Email:
Phil@commodex.com
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