During an economic recovery, future demand expectations trumps current supply data bidding up futures for crude and refined products. This is why the energy complex has been on a relentless upward trend for the past two years. Seasonal refinery output factors that normally temper price movements have had little effect this year. Why is this happening?
The simple answer is that speculators have gone all in on long positions, taking profits at resistance levels and then repositioning long trades at support levels. This has prevented any sustainable sell off. It has also positioned term structures to move from a well supplied backwardation market to a high demand contango market.
The EIA released gas supply data last week showing gas supplies have been steadily increasing. Despite the ample supply, they are giving a 10% probability that retail gas prices will hit $4.00 per gallon, with a 50% chance of gas prices hitting $3.50 per gallon in 2011.
One hope for consumers is that everyone is leaning heavily to one side of the ship. Should a major demand or several demand reducing events occur in 2011, there will be a lot of traders trying to exit through a small door at the same time. Such an event would be China overshooting on its attempts to dampen its inflation. Another listing of the ship event would be the failure of several Eurozone banks.
Since neither of these events are highly likely to occur, traders will not try to rock the boat and continue positioning for the likelihood of a continued bull market.
Saturday, January 22, 2011
Saturday, January 8, 2011
Falling Bond Prices Effect on the Energy Complex
Ben Bernanke and the US Federal Reserve are in the process of buying up $600 billion in treasuries in hopes of keeping interest rates low to help stimulate the economy. Bonds, however, are misbehaving. Interest rates on the ten year note is approaching critical technical levels that if broken, will likely set the stage for a secular bear market in bonds. Mr. Market is in the process of breaking apart long held economic theories.
Theoretical economics can be completely mind blowing. Yet no matter how complex the theory, in the long run, it will always need to obey the very simple laws of supply and demand. The acid test of any economic theory is whether or not a hypothetical idea plays out in the market. Ben Bernanke is hoping that injecting $600 billion into the economy buying treasuries will force interest rates down. Yet interest rates are going in the opposite direction. Why? And will this have any effect on the energy market?
The simple answer to why interest rates are heading up instead of down is that money flows are moving out of bonds with fears of future inflation diluting value.
Bonds have been in a secular bull market for the past twenty years. Bond traders are now carefully monitoring two year resistance of 4% on the ten year. Should this level give way the next major line of resistance comes in at 5.5%. A breach of interest rates above 5.5% by either the ten year or thirty year bond will be a strong signal to most bond traders that the long run of the bond bull market is over and a new secular bear market has begun.
If the bond market turns secularly bearish, will this tame the relentless bull market in energy? Probably not much. Upward trending interest rates are not good for any economy. Higher borrowing costs will be past along to consumers. The ultimate result is rising prices; inflation.
Crude oil remains a scarce resource. Light crude oil even more so. Long term continuation of falling bond prices will eventually lead to another recession. This may not happen for several years. Until then, demand for crude and its refined products will continue unabated supporting prices, keeping the secular crude bull market in place for several years to come.
Theoretical economics can be completely mind blowing. Yet no matter how complex the theory, in the long run, it will always need to obey the very simple laws of supply and demand. The acid test of any economic theory is whether or not a hypothetical idea plays out in the market. Ben Bernanke is hoping that injecting $600 billion into the economy buying treasuries will force interest rates down. Yet interest rates are going in the opposite direction. Why? And will this have any effect on the energy market?
The simple answer to why interest rates are heading up instead of down is that money flows are moving out of bonds with fears of future inflation diluting value.
Bonds have been in a secular bull market for the past twenty years. Bond traders are now carefully monitoring two year resistance of 4% on the ten year. Should this level give way the next major line of resistance comes in at 5.5%. A breach of interest rates above 5.5% by either the ten year or thirty year bond will be a strong signal to most bond traders that the long run of the bond bull market is over and a new secular bear market has begun.
If the bond market turns secularly bearish, will this tame the relentless bull market in energy? Probably not much. Upward trending interest rates are not good for any economy. Higher borrowing costs will be past along to consumers. The ultimate result is rising prices; inflation.
Crude oil remains a scarce resource. Light crude oil even more so. Long term continuation of falling bond prices will eventually lead to another recession. This may not happen for several years. Until then, demand for crude and its refined products will continue unabated supporting prices, keeping the secular crude bull market in place for several years to come.
Saturday, January 1, 2011
Will Crude Gain Another 15.1% in 2011?
The year 2010 was a great year for the bulls in almost every market. Equities around the world were higher. Gold, crude, bonds, US dollar, copper, wheat, corn; all paid handsomely to market participants trading long. With the economic recovery continuing to gain momentum, should traders simply repeat 2010 winning strategies, or has the long only trade become too crowded for 2011?
For energy traders the key to future prices heavily rests on future demand. Since the US and China are the two largest energy consumers, an investor's energy demand forecast for these two countries, will largely dictate the proper trade.
China is imposing higher reserve requirement and higher interest costs for banks to slow down growth. The Chinese government will likely be successful slowing growth. Still, they will likely continue to see GDP growth at 8% or better in 2011.
One other important factor in China's crude consumption overlooked by many is China's desire to build greater emergency reserve capacity. I like to call this factor the Chinese put. When crude prices dipped down into the $70's handle last summer, crude tanker shipments into China increased. Why? China has become an astute energy trader. They were busy buying up all available crude at cheaper prices and placing the barrels into emergency storage. They will repeat this exercise on any major market downturn, effectively giving long traders a free stop loss put.
With all the talk about China, the United States is still the number one consumer of crude, gas and diesel. Should the US fall back into another recession this year, energy prices will be affected dramatically. Unlikely as this might be to happen, traders will need to keep monitoring events in Europe that would have the potential to derail the US recovery. The problems with several Euro member sovereign debt are real and they are serious. If the debt is not handled in a real and serious manner, banking collapses will cause worldwide economic pain.
With demand finally chipping away at supply, crude, gas and diesel futures term structures are moving decisively from a contango market to a backwardation market. It is almost never wise to be short any commodity that is in contango, as products are coming out of storage and being sold decreasing forward supply.
Crude bears reading this may be screaming that the falling euro and strengthening US dollar is being left out of my 2011 forecast. And the bears are likely to be correct in this currency trend continuing in 2011. The stronger US dollar will help to alleviate a quick rise in crude to $149. However, 2011 is likely to be a year that breaks past correlations, with equities, commodities and the US dollar all rising together. Remember, currencies are driven by interest rates. US interest rates are on the rise.
In 2011 we may see crude gain 10% to 15%. Should the market give up some ground, traders should take advantage and add to long positions knowing the Chinese put is in place.
Happy New Year everyone!
For energy traders the key to future prices heavily rests on future demand. Since the US and China are the two largest energy consumers, an investor's energy demand forecast for these two countries, will largely dictate the proper trade.
China is imposing higher reserve requirement and higher interest costs for banks to slow down growth. The Chinese government will likely be successful slowing growth. Still, they will likely continue to see GDP growth at 8% or better in 2011.
One other important factor in China's crude consumption overlooked by many is China's desire to build greater emergency reserve capacity. I like to call this factor the Chinese put. When crude prices dipped down into the $70's handle last summer, crude tanker shipments into China increased. Why? China has become an astute energy trader. They were busy buying up all available crude at cheaper prices and placing the barrels into emergency storage. They will repeat this exercise on any major market downturn, effectively giving long traders a free stop loss put.
With all the talk about China, the United States is still the number one consumer of crude, gas and diesel. Should the US fall back into another recession this year, energy prices will be affected dramatically. Unlikely as this might be to happen, traders will need to keep monitoring events in Europe that would have the potential to derail the US recovery. The problems with several Euro member sovereign debt are real and they are serious. If the debt is not handled in a real and serious manner, banking collapses will cause worldwide economic pain.
With demand finally chipping away at supply, crude, gas and diesel futures term structures are moving decisively from a contango market to a backwardation market. It is almost never wise to be short any commodity that is in contango, as products are coming out of storage and being sold decreasing forward supply.
Crude bears reading this may be screaming that the falling euro and strengthening US dollar is being left out of my 2011 forecast. And the bears are likely to be correct in this currency trend continuing in 2011. The stronger US dollar will help to alleviate a quick rise in crude to $149. However, 2011 is likely to be a year that breaks past correlations, with equities, commodities and the US dollar all rising together. Remember, currencies are driven by interest rates. US interest rates are on the rise.
In 2011 we may see crude gain 10% to 15%. Should the market give up some ground, traders should take advantage and add to long positions knowing the Chinese put is in place.
Happy New Year everyone!
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