Black Gold: The Last Of Bernanke’s Bubbles

POSTED ON September 03, 2013 BY Alim Abdulla
CATEGORY Energy, Oil and Gas,

(Bond: Quantum Of Solace)

This is not a short call on Oil, not yet at least, but this is recognition that the last of Bernanke's bubbles has yet to begin deflating and therein lies the potential opportunity. With the US Dollar strengthening against 14 of the world's 16 major currencies this year, commodities have taken it on the chin year-to-date; Oil has not. President Obama has resided over the weakest US Dollar of any American President in history, and not surprisingly, the highest average price of Oil. The US Dollar, however, has found support after bottoming at a 40-year low in August 2011 and this year has been making higher-lows and higher-highs, thus far. Tapering is late and is required for further economic growth because its causal impact is US Dollar bullish; the basis of the Consumption Growth thesis.

The potential scenario in which Oil could have a near-term (3-months or less) move higher is US military engagement in the Middle East region, currently Syria. But unless this turns into an all-out military commitment to the region, as well as results in a prolonged disruption to Oil production and/or supply, the move higher will be short lived. A disruption in the production of Oil would require other Arab nations to be embroiled in the conflict; Syria’s annual Oil production is approximately 400,000 bbl/day (0.48% of the world’s production according to the International Energy Agency). A spike could potentially offer an enticing short opportunity; we'll have to see how the numbers shape up.

The two potential scenarios in which Oil could have a significant decline over the near-term: 1) The US Dollar continues to gain relative strength and tensions ease in the Middle East region and/or the US media is directed to focus on selling some other fear; and 2) A sustained elevated price of Oil chokes off consumption growth and both Oil and the US markets get tagged. A weak currency and sustained elevated Oil prices do not benefit anyone but those who directly profit from it.

If the US is to experience a further acceleration in economic growth (US GDP for Q2 2013 was 2.5% versus 0.38% in Q4 2012 when growth started to stabilize), a stronger currency and a lower Oil price is essential. Keith McCullough has it right when he says: down Oil would be the most bullish economic catalyst year-to-date; the 40-year average inflation-adjusted price of Oil (WTI) is $52.91, today we are trading at $108.55. As Hedgeye has pointed out, both Presidents Reagan and Clinton adopted strong Dollar policies via tax cuts:

Average Price of Oil 1983-1989 = $22.16/barrel, Average US GDP Growth +4.31%
Average Price of Oil 1993-1999 = $18.63/barrel, Average US GDP Growth +3.84%

There is a massive vested interest in maintaining elevated Oil prices both within the industry and by governments. Tech, Real Estate, Gold and Bonds all had similar vested interests; for Gold and Bonds the fight against the free market continues. Central banks of the world, in their foolish attempt to manipulate and deny the natural course of economic cycles, have created massive price distortions.

There are three broad market themes working against the price of Oil currently: 1) A strengthening US Dollar 2) Rising rates; and 3) Capital exiting Emerging Markets. Of course, if these trends change the game changes. Always remain data dependent; no one is smarter than the markets combined intelligence of all participants. I do not know what the Godfather Ben Bernanke will do next because I have no idea what his personal agenda is, nor do I use professional liars as a market source. What I do know is that the market has been front-running a taper for 10-months. The alerts are flashing for Oil and as any prudent risk manager would I am assessing the upside and downside risks, and will act accordingly when the market and research dictates to do so.

Until then I will continue to ask myself questions: Is the World coming to an end? What is the catalyst for sustained higher Oil prices? What happens if the US Dollar continues to strengthen? Will the market continue to disregard Bernanke’s fairytales and push yields higher? The answers to these questions are provided by Ms. Market; she’s very generous if you only spend the time and listen to her, otherwise be prepared to feel her wrath.

“The market is smarter than you will ever be, with its combined knowledge of all participants. Pay attention to the signs. Be quick to admit that you’re wrong. Don’t be afraid to miss something.” - Yra Harris, Praxis Trading

Alim

Alim Abdulla is an Investment Advisor at Leede Financial and is a co-founder of the Trading Analytics Group (TAG). He has been with Leede for nine years and began his career in the Financial Industry a year prior at Canaccord Capital. Alim considers himself to be an Active Risk Manager focused on long/short equity portfolios.

Disclaimer: The comments and opinions expressed herein reflect the personal views of Alim Abdulla. They may differ from the opinions of Leede Financial Markets Inc. and should not be considered representative of the research beliefs, opinions or recommendations of Leede Financial Markets Inc. The information included in this document, including any opinion, is based on various sources believed to be reliable, but its accuracy and completeness is not guaranteed. Member CIPF.

Alim Abdulla

aabdulla@leedefinancial.com

Alim Abdulla

aabdulla@leedefinancial.com

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