We have seen how Gold and Silver were viciously attacked by the shorts this past week, and surprisingly Oil escaped the carnage which is interesting because in April Oil was taken down to the $86 level during the last attack on the Gold and Silver markets. This is even stranger considering the fundamentals for the Oil market are even more bearish than they were in April from a supply standpoint as exemplified by the latest EIA report on Wednesday on this week. There is little doubt however that since the easy money is gleaned from the Gold attack, the Feral Hogs will start looking for their next target, and the Oil market will be high on their list in the upcoming months as the summer driving season winds down, and bulging supplies start to weigh on trader`s sentiments.
This week`s EIA report identifies the problem with the Oil market as we had refineries running at the highest utilization rate of the year at 90% and yet there still wasn`t a draw in crude supplies. There have only been like 4 or 5 draws the entire year in Crude supplies. With Oil inventories above 390 million during the strong part of the year for oil demand, what happens to supplies when the slower part of the demand cycle kicks in for petroleum products?
Gasoline supplies are well above where they were last year at this time, and distillates are slightly ahead of last year`s inventory levels for this time of year. And for all that talk about added pipelines out of Cushing alleviated the Cushing Oil glut; you guessed it, Cushing supplies are higher now than during this same time a year ago. This is hilarious considering the spread between Brent and WTI last year, compared to the $5 spread today. But that is the thing you have to understand about the Oil market: It is one of the most manipulated markets in the world. There is just so much money to be made in the Oil business and markets that the incentives for manipulation with lax oversight are just too inviting for the large players in the industry.
Take your pick either the spread should never have been $25 to begin with, or it shouldn`t be $5 today because nothing has changed at Cushing, Oklahoma. In fact. there is even more oil stuck in the Midwest so to speak which was used as the rationale for having the spread in the first place, and rhetoric for why the spread was going to go away! More lies and propaganda used to push positions for profit! The entire spread is a complete farce. Well, it was either a farce then or it is now because having both conditions given the actual data is illogical.
The headwinds for the oil market are as follows: The entire BRIC and emerging markets commodity inspired theme has come to an end from Brazil to India to China. In fact, some emerging markets seem destined for a crash. And the biggest Oil consumer of the BRIC play-- China-- may be growing at less than 6% in real terms. You don`t have to look at China to realize how bad it is in China for growth of commodities just look at the other commodity producer countries of Australia and Brazil to see just how much China has slowed in its consumption of raw materials, i.e., the fall in Iron-ore prices.
Moreover, the PMI`s coming out of China are going in the wrong direction, they aren`t getting better, they are starting to accelerate to the downside, and that was before the credit crunch of late. In addition, it appears too much past stimulus is part of the problem in China with regards to solvency issues and the shadow banking crisis that additional stimulus from the Central Planning Authorities is unlikely anytime soon.
The next headwind is a strong dollar and despite Fed officials trying to talk down the dollar and bond market yields in the rest of the world is in far worse shape than the United States. Emerging market and Commodity currencies are imploding against the dollar. With the advent of the weakening Yen strategy of Japan, the dollar seems destined for much higher levels. A higher dollar means commodities which are based and traded in dollars becomes more expensive, and is a bearish driver for prices.
Consumption is down in the biggest user of petroleum products the United States, while the emerging economies like China and India are really struggling economically, which is needed to offset the decline in US consumption. This is the real reason the Brent – WTI spread has come down with China not building a new city every month like they were in the developing phase. India is in the midst of a recession, and Europe automobile sales is at record lows. Nobody is going to pay higher prices for oil at the global level – and Brent is considered the Oil Benchmark for international demand. Brent under $105 tells you demand sucks internationally because if the players had their way Brent would be closer to $130.
Oil output and production is up globally, with US leading gains in the domestic US market not seen in decades. But here is the kicker for why Oil is in for larger inventory builds for the fall. The Saudi`s raise and lower production seasonally, i.e., they ship more to the US during the Driving season, and less in the Fall. But the US production is constantly rising because these are projects that are just trying to maximize production from an efficiency standpoint. So this new capacity comes to market regardless of the current supply levels or current seasonal demand patterns. You see this in the fact that we should be experiencing draws right now in Crude supplies as refinery utilization rates increase to produce more products for the seasonal driving demand. But yet we are flat or have had slight builds in Crude supplies because US production is making up the difference for season demand. The equation for the fall is the Saudi`s slow production as refinery utilization rates come down, but the US production still continues at or above the same rate and Oil supplies build with total supplies crossing the 400 million threshold.
Even the Middle East is looking less threatening for potential supply disruptions with Iran electing a much more moderate leader this time around. An Iran attack that was thought to be a possibility is looking less likely by most of the scholars on the subject from the political think tanks analyzing the latest dynamics. It looks like there will be a deal to scale back the size of the nuclear program in Iran which appeases Israel and the United States, and lifts the sanctions in Iran who need the economic boost as practical concerns have taken precedent over ideological drivers in the country`s politics.
In short, almost every argument used in the past to support higher oil prices is actually heading in the other direction. We haven`t even touched on the fact that there seems to be a problem of deflation, and not inflation, when it comes to commodities in general. All other commodities have deflated far more than Oil has, and especially if we take WTI which is up for the year. This seems like the outlier that stands out, and will be correcting in the future. The price of WTI doesn`t match the fundamentals of the rest of the commodity complex, or even the fundamentals of its own supply and production levels.
The real question is when will the Feral Hogs fix their sights on the WTI market, and take it down to $80 like they have the last two years. My guess now that they have had their fun with the Gold and Silver markets, they will start looking around for their next target. The WTI price just stands out among the other commodities like a sore thumb. If they can take Gold down below $1200 on a couple of arguments, it seems there are at least five major arguments for taking WTI down to $80 in their next shark attack. Just watch out for all the I-banks coming out with their “research reports” after they are properly positioned for their takedown like we saw in Gold.