QE2 and It Ain't the Queen Elizabeth

Energy traders placed their bets with Ben Bernanke on Friday that he will keep the economy moving forward even if it means another round of quantitative easing (QE2). As much as the Fed would rather stay on the sidelines and let the free market work, stubbornly high unemployment may force the Fed to expand their balance sheet, buying more bonds to drop interest rates even lower.

Energy bears had a nice run the past few months, riding the falling price of crude from a near term high of $83 down to $71. Traders are now trying to make their best guesses as to how demand will be shaping up for 2011.

Everyone is well aware how well supplied markets are for crude and its refined products. Contangos continue to widen, with refiners preferring to arbitrage prices by storing crude instead of refining into current low margin products.

Energy bulls have been relying on China to offset anemic fuel demand. The US, however, is still the leading fuel consumer and will be a drag on futures if employment in US cannot get below 9%.

The Fed can only do so much. Entrepreneurs need to have confidence and surety that invested capital will generate sufficient returns. Perhaps confidence will return after the November elections. For now the safest trade is to wait for energy futures to hit monthly resistance levels and then join the bears for profits on the short side of the trade.

Widening Contangos and Crude Evaluations

Energy traders incorporate a wide variety of trading tools to estimate future values of crude and its refined products. No matter which commodity one is trading, nothing is more important than understanding whether current or future demand is being given a higher valuation for the given commodity.

Other than being lucky in guessing future valuations, how does a trader know right now whether current prices will likely go higher or lower? The answer is in looking at whether suppliers are bidding up outlying month futures and storage cost pricing. Ultimately these prices are driven by current vs future demand.

Crude outer month futures prices have been on the increase in relation to near month pricing. Traders use the term contango, not sure why but it is what is, to describe any commodity whose current prices are less than future prices. When prices spreads between near and outer months continue widening, near term prices are highly likely to continue falling.

Crude futures normally, or at least historically, will trade in a backwardation price structure. This enable refiners to refine crude as refined products prices rise. Refiners profit margins fatten in this type of environment. In contango, refiners find themselves in a shrinking profit margin due to falling refined product prices. This results in refiners delaying or reducing their crude purchases, hoping product prices may be higher in the future.

With the euro on the verge of collapsing below $1.27 support, traders will be wise to observe the widening or narrowing of crude the contango, as trading plans are executed over the next few months.

Absolute Monetary Policy Clarity Now From the US Federal Reserve

The US Federal Reserve Open Market Committee is the single most powerful entity affecting investment decisions across the entire world. For the past twenty years or so investors were never really quite sure of the Fed's monetary policy because the Fed's focus was on targeting interest rates and/or targeting reserves. This left investors trying their best to interpret Fed comments on their committee meetings to determine these targeted ranges.

On Tuesday the Fed announced it has changed its policy to targeting its balance sheet. Hallelujah!! It is now a simple matter of doing the math as to whether the Fed has expanded or contracted its balance sheet to determine whether the Fed is easing or tightening monetary policy.

The US dollar was off to the races once the market truly understood the implications of this momentous decision. Unfortunately, those long energy futures were hammered this week mainly due to the swift fall of the euro on the heels of this change in Fed policy.

Congratulations to South Carolina's Ben Bernanke for driving home the need for change to the other members of the Federal Open Market Committee! The TV business news channels will surely miss parsing Fed meeting communique, but for investors who need to know exact monetary policy direction, this is a great win for the US and global economies.

Don't Turn Out the Lights Yet

One of my favorite childhood memories was watching Monday Night Football back in the days when Frank Gifford, Howard Cossell and Don Meredith were the commentators. Hearing Howard and Don exchanging verbal jabs was a weekly treat. Seeing how this show came on a school night, my parents would not let me stay up past half time. Unless of course, our local team happened to be featured that evening. When a team was losing badly going into the fourth quarter, Don Meredith used to sing the words of an old country song, "Turn out the lights...the party is over". Crude bears may be tempted to begin singing this song to their bull counterparts after the release of Friday's US Jobs data. Bulls ought not to listen.

Sure the Jobs report on Friday was dismal. Not a big surprise. Companies in the United States want to see demand for goods pick up before they will hire new employees. In the meantime, companies are finding more ways to automate labor intensive processes. Not a pretty picture for recent college grads or those still trying to find work from the Great Recession. However, the increase in productivity enables companies to quickly meet demand for goods as this demand slowly but surely increases.

Crude bulls are well aware we are approaching the meat of hurricane season. Traders are also taking note on the rapid rise in wheat prices pulling other commodities higher. The euro too is lending support to energy futures.

So, while $100 crude will need to wait, barring some type of catastrophic event, $80 crude may be a good entry point to ride the trading range back to $85.