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May 2013

The Macro Story as Told by Gold, Copper and Oil

May 22, 2013 by EconMatters   Comments (0)

By EconMatters

Gold’s been on a wild ride.  After reaching a peak of $1,920 an ounce in September 2011, gold has tumbled 28% to the current ~$1,380 level forcing John Paulson to take a 47% loss in his gold fund during the first four months of this year, according to Bloomberg. 
Unlike Paulson who maintained his positions in gold, other big players like George Soros and  BlackRock cut their gold ETF holdings, while Goldman Sachs issued a sell recommendation on gold right before the yellow metal plunged 13% through April 15, the biggest drop in three decades.  And by looking at the futures curve (chart below), market does not seem to expect gold to come back roaring any time soon. 
Chart Source: S&P Capital IQ
QEs Not Hitting the Real Economy

Historically, gold is regarded as a good inflation hedge and store of value, typically thriving in an environment of high inflation, and/or weak U.S. dollar (currency debasement).  With U.S. Federal Reserve’s three rounds of QE, the never-ending debt crisis in the Eurozone, hyperinflation and dollar debasement seem inevitable and supportive of gold for the long run, right?    
  
Theoretically, Fed’s QE and near zero fed funds rate is supposed to encourage borrowing and spending from the private sector thus injecting money into the real economy.  However, theory and reality don’t always see eye to eye. 
Since the 2008 financial crisis, banks have significantly tightened the credit standard and are reluctant to lend.  On the other hand, corporations are making money mostly from “streamlined” headcount and structure, but instead of the intended wealth distribution effect expected by the Fed such as investing back to the economy, or increase employee pay which would in turn increase consumer spending, most corporations are hoarding cash or use profits for dividend, share buybacks, or mergers & acquisitions with limited impact on the real economy.     
Copper & Oil Indicating Weak Demand

The weak demand is also reflected in part of the commodity market fundamental.  WTI crude oil inventory climbed to 82-year high and copper inventory at LME hit a 10-year high in April, while Goldman Sachs cut its “near-term” outlook for commodities. 
Although some have argued oil and copper have lost their significance primarily due to increasing domestic oil production, and “temporary” excess copper supply.  While the abundance of domestic shale oil production may have distorted the historical supply and demand relationship, but with the U.S. becoming the world’s largest fuel exporter, the fast and furious oil inventory build is nevertheless still an indication of a weak world economy.  And I can’t imagine how the “temporary” buildup of copper inventory is not a sign of weak global economic condition?
Massive QEs, Limited Inflation?

On top of the overall weak spending and demand in the private sector, most of the developed countries are undergoing some shape or form of austerity with reduced government spending.  China, the growth engine of the world, is having some problems of its own.  The old-fashioned massive infrastructure building QE program got China through the 2008 financial crisis, and was the main driver behind commodity prices.  But Beijing can’t afford another QE due to inflation concern (plus China has probably run out of things to build).  Low wage levels means China consumers can’t really pick up the spending slack, coupled with bad credit problem (i.e., NPL: Non-Performing Loans), and recent capital flight, which had many analysts worried enough to downgrade China’s growth prospect.  
The simultaneous pullback from both the private and government sectors in U.S. Europe, and China is a major factor why Fed's massive QEs have resulted in only limited inflationary pressure and increasing signs of deflation.  
Dollar and Carry Trade Kills Gold

Nonetheless, when compared with Europe, China or any other regions in the world, the U.S., seems relatively more stable, and has been able to retain the “safe haven” status despite its own debt problem.  With investors pouring money into U.S. equity and bond propping up the dollar, and weak demand suppressing inflation, two of the main conditions for a strong gold price -- high inflation and a weak US dollar -- are basically non-existent in the current macro environment.  Furthermore, there was already a bit of disconnect between gold and the other commodity prices such as copper, and oil.  So eventually, gold had to come to grip with the macro reality.    
Chart Source: Stockcharts.com
Another major factor against gold right now is that gold has no yield and is out of favor with the huge yield-seeking yen carry trade crowd (borrowing yen to invest in higher yield options) since bond and equity now are offering much better returns.  Unless there's a shock to the system such as a war breaking out in the Middle East, or an eventual debt crisis in Japan when people would seek safety, there's not much upside momentum for gold.

Gold's Volatility Game

For now, the prevalent view is that the Fed will slow or exit QE3, and gold is out of favor under the the current macro trend.  For example, Lim Chow Kiat, the chief investment officer of the Government of Singapore Investment Corp (GIC), thinks gold still looks overpriced as the usage of gold for industrial or consumer products doesn't quite justify the prices.  GIC is one of the world's largest sovereign wealth funds.

As long as dollar maintain its strength and inflation remains tame, gold prices most likely will see considerable volatility swinging between rumors and speculation (e.g., some central banks may need to unload some of their holdings due to debt crisis), and Asia retail buying on the dip (South China Morning Post reported that many shops in Hong Kong were running out of the precious metal for the first time in decades.)

Technically speaking, gold's next support level should be $1,330 range with $1,320 as the major support when most physical retail buyers would rush in.  If gold breaks below $1,300 hard, expect a major liquidation when even Paulson could be forced to sell and everybody piles in.  

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Oil Market Manipulation Reaches Absurd Levels

May 21, 2013 by EconMatters   Comments (0)

By EconMatters

Markets & Manipulation: A long History
Most markets these days are manipulated to some extent, and this is nothing new if we look back through the history of financial markets. But there are some strange things happening right now in the oil market worth mentioning.

Computer Pegging Algo

For the first time ever in the history of the oil market the June and July WTI Futures contracts the last 2 days have had the exact same price tick for tick. The June contract is rolling over on Tuesday, but normally the front month and rollover month have different prices, a typical spread would be in the range of 30 cents. But the two months are always priced differently. It is unheard of for the two months to have the exact price tick for tick for 2 days.
 So what is going on here? It is obvious that a computer is pegging both markets, and that this is a new approach to a typical manipulation scheme of running up a contract at rollover, so those who need to rollover, pay the highest price to do so. There is nothing new about this scheme it goes on in Brent and WTI all the time for years. But this is the first time that it has been done with such brazen and open contempt for regulators that they just peg the two WTI months to the same price for 2 days via a computer program. 
Brent-WTI Spread/Scam
Another scam in the Oil market is the Brent-WTI spread this has been one of the biggest scams over the years in the Oil market. Just to provide some data to the absurdity which is this much hyped about nonsensical spread Cushing Oklahoma has 49.7 million barrels in storage, it had 45.1 million barrels in storage a year ago.  Cushing had 50 million barrels in storage at the start of the year. Moreover, in June Cushing will be adding additional supplies to storage due to current pipeline capacity going offline. So for all this talk about pipelines finally unlocking all the glut of oil supplies from the Cushing hub, and this being the reason for the impressive reduction in the Brent-WTI spread it is just a bunch of nonsense. 
Cushing Oklahoma Supply Glut
So there is basically more oil trapped in Cushing Oklahoma then there has ever been when the spread was 25! So regardless if the spread is 25 or 8 it has very little to do with supplies residing in Cushing Oklahoma that is quite evident. Now there are a bunch of factors contributing to the nuances of the spread which I will not go into detail here but the takeaway is just to point out the absurdity which is the false and misleading rhetoric that encompasses this spread and Cushing Inventory levels. 
400 Million Barrels & Climbing
While we are talking about inventory levels it is funny that WTI sits at $97 a barrel when the entire year we have had basically 3 minuscule draws in inventory supplies which stand at a record breaking 395 Million Barrels in storage. So the Dow keeps hitting new highs every week, and the US keeps setting new modern records for Oil in storage each week.
Weak Demand in an Artificial Economy
But it is not just the supply issues in an obviously oversupplied oil market with the US domestic production being the biggest culprit. The demand side of the equation has been equally bearish for the fundamentals with China`s actual economy slowing over the past 2 years, Europe being stuck in a perpetual recession, and the US being a mature market with higher fuel standards and a stagnant economy that requires $85 Billion of stimulus each month to keep from cratering. The demand side had been very underwhelming from the products side of the equation. For example, Gasoline supplies in the northeast are 10% higher than normal for this time of year.
Strong Dollar Bearish for Dollar Denominated Commodities
Finally the strong dollar is supposed to be bearish for commodities and oil, and with the US Dollar Index hovering around 84 and threatening to strengthen from these levels it is a wonder that the Oil market has barely noticed this strange occurrence in Dollar strength, unlike the Gold and Silver Markets. 
Fundamentals: Are we talking about the Fundamentals Again?
The takeaway is that none of the actual fundamentals ever matter in the Oil markets. When you have a house style advantage that would make any Las Vegas Casino envious the fundamentals play little part in a manipulated Oil market. It is all about protecting the huge supply chain that is the oil market and everybody`s livelihood. When in doubt follow the money trail, and money is the biggest reason oil prices are where they are currently despite the bearish fundamentals of the commodity. Oil prices wouldn`t be at these levels if the powerful manipulators of the commodity were not making a whole lot of money as a result.
Oil Analysts Clueless
So the next time some Oil analyst tells you some hard studied reason why Oil prices are up it is all nonsense. Oil prices are up or down depending upon what the powerful players want oil to do, one week it can be at $86, the next $97, or $77, it is all about the money to these players, and they will do whatever it takes to make the money. And if it means being very creative with their methods then so be it, it is not like this is a regulated market!

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