Saturday, November 28, 2015
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Week Is Almost Done


Today was not the follow through I had hoped for. Following yesterday’s rally, in both stocks and commodities, I had wanted today to run but it was cut short. Oil retreated, reaffirming that markets are quite content to keep oil range bound in the mid $40’s so that the sector stays on a path of imminent destruction.

As the saying goes, “The beatings will continue until morale improves.”

Gasoline inventory numbers showed a big drawdown, which sparked yesterday’s rally. Stocks at Cushing also declined by 748,000 barrels, although overall stocks grew by 4.1 million barrels. I am expecting to see the US inventory growth slow dramatically going into the holidays, with word that companies who have hit their operating budget are going to take a recess for the last month of the year.

Big news out of China today that they are increasing their child “rations” to 2 per couple. This is such commie nonsense, it’s hard to take it seriously. Such rules are written by megalomaniacs; so much arrogance goes into trying and restrict population the way China has done. It is a blessing that the outcome has been so terrifying for China’s ruling party; their culture values boys, so they have way too few girls. A sea of 20 year old men without the main thing that keeps young men from dabbling in revolution – family.

You don’t just switch off and fix that problem over night.

Finally, American politics is as awful as ever. The GOP debate last night was a debacle for CNBC, which has managed to disgrace itself in two separate journalistic professions now.

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Market Update – 18 Months In Review

2014 began with an intense implosion of overpriced tech stocks that destabilized players and set us up for nasty knock off effects. Months afterwards, energy names began to turn downward and started an at first slow descent; a black omen for anyone looking for a forward indicator.

Saudi Arabia decided to play the world’s worst move (effectively maiming OPEC), spiked the oil markets when they could least handle it, and sent oil into the abyss touching off a second massive sector implosion in oil and gas names. But not just oil & gas, as the market became terrified of economic stagnation led by fears out of Europe and Asia, and the entire energy sector followed oil down the hole.

We are now experiencing what I view as the third wave of the same phenomenon that began in early 2014, more than a year later, as the entire stock market collapses 10% in a short span of time, led by China’s markets and the intensely poor decision making of a command/control economy trying to have their cake and eat it too.

That being said, I haven’t yet seen any indication that the real economy is retracting.

Job growth seems present and in my own local markets where I have a good ear to the ground concerning hiring and pay policies, I am actually hearing talk of wage hikes. The last five years, our local job market at least was terrified of the HR monsters that were federal regulations (chiefly PPACA), not to mention we are still reeling from 2009 in some respects. But I think as we clear away from the implementation of these federal regulations, especially with rigid conservatives now holding fast against, we are going to start to see some wage growth. Employees are actually demanding it now, voting with their feet when they can.

This should do wonders for the economy.

With regards to oil specifically (which is chiefest of my concerns) the EIA is suggesting that the current imbalance between consumption and production of oil is 2 million barrels per day. This is the cause of our stockpiling and the foremost reason oil has sunk so far. Saudi Arabia’s move to curtail US production has been a failure and so far the long feared wave of insolvencies has held to a slow drip, even from the most precarious of businesses.

A 2 million barrel imbalance is not all that bad and I believe that, barring some sort of real demand destruction, we’ll just float along at these levels until the market becomes more comfortable with oversupply. I don’t think oversupply necessarily will force pricing lower as it would take a very specific set of circumstances which include not having a merger & acquisition brokerage occur. Yet we see M&A activity is very healthy in this current time period and I have to believe that if oil goes much lower you would see US markets consolidate aggressively.

Besides this, the global imbalance is equivalent to about one major oil producer globally. And in this current environment, we also should be aware that civil unrest is a powerful destabilizer of oil production (via civil war) with positive likelihood.

Sources of new supply are questionable. New well development at these oil prices are unprofitable and only large state sponsored development is probable. Yet, economic weakness is harming state budgets and may make it difficult to attain approval for unprofitable ventures. The largest foreign state controlled sources of oil are also some of the most sensitive to this oil price shock.

Altogether, I continue to believe that the most likely outcome in oil markets is unknowable yet still predictable production locations going offline from internal unrest. Venezuela is pegged as the most likely location for such an event, do to the extreme nature of their current state of affairs, and because their leadership is proven incapable of handling the situation. But Venezuela is hardly the only candidate; just the best.

Outside of that, the economic uncertainty that hit everyone’s radar earlier this summer is now coming back under control. Bond yields continue to subside across all major foreign issuers, and I would not be surprised if the EU crisis in particular remains hidden from view for another full two years.

Domestically, I expect monetary policy to remain accommodating, but would not be surprised if Yellen raises interest rates some token amount, to try and claim some victory for the Federal Reserve. I cannot expect how the market will react to his, but believe the raise will be mostly symbolic anyway, so any effects should be temporary in nature.

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Big Europe Makes The Move…Hopelessly

This weekend, the Eggs Benedict Presidency himself, Mr. Francois Hollande, is calling for a new government to unite all of Europe. This is the last ditch effort of redlining welfare states to avoid change. If they can create a unified government, the Greeks, Spanish, Italians and French can have a fair shot of papering over their floundering social nets without being forced to undertake any meaningful reforms.

And they have no chance of pulling it off. The mood has decidedly swung against “Europe”. Plus Germany isn’t that stupid.

But it’s quite amazing that we’ve gotten to this point at all and it’s worth spending a few minutes talking about the progression itself. Because just fifty years ago, it would have been unthinkable for an elected leader of a European country to call for full integration of the continent.

It’s worth starting the narrative after the end of World War 2; mostly because so many people were dead at that point that it was essentially a complete reset of the culture anyway. History before World War 2 exists as a sort of odd, discolored picture in time…one who’s inhabitants are almost forgotten.

And as Europe began to pick up the pieces, ghastly images began to emerge of a culture that did unspeakable acts. The death and carnage was so pervasive that it had the almost singular effect of destroying one of the more popular scientism movements – eugenics – practically overnight. As word of the concentration camps that the Axis had erected spread, very uncomfortable associations between our own work with forced sterilizations and gene and culture control here at home began to creep up, and almost instantaneously no one had ever believed in eugenics (despite it being almost blasphemy to argue against it just years early). Michael Crichton had a very excellent speech on this subject and if you haven’t read it, I recommend it in its full form.

And a major knock off effect of this self reflection was a Europe which had become more afraid of its own citizens than ever. I recently read another article (I couldn’t track it down, leave a link if you know the one) that I feel convincingly argued that much of the current EU form was erected to overrule democracy in favor of technocratic decision making by an “enlightened” class. If you want an example of how this plays out, consider that in the UK upwards of half of all new laws originate from Brussels. Lawmaking of this variety clearly denies basic rights of representation; and indeed that is the whole point.

Per this argument, the EU’s terror of its own citizens – which is at the heart of the EU rule making process – is a cultural development in response to the acts of populist movements across Europe in the prior generation.

But this is something of a contradiction. It wasn’t exactly democratic actions that committed those atrocities. Certainly a very vocal and nationalist undercurrent of supporters set those things in motion. But talking to the survivors of those years, one fairly consistent theme is that the common citizens that formed the backbone of the democracies had almost no idea of what was going on.

Rather, it was the very same form of technocrats, withholding information and utilizing propaganda, that had carried out the worst human rights violations. A lack of information stifled the ability of democracy to react, until much later, after the veil of ignorance was lifted by warfare, and the sights and accounts were allowed to flow through the populace.

And so it is also worth considering that it would be exceedingly difficult for any atrocity on the scale of the early 20th century to happen again in our history, so long as the information sharing which is reshaping our society is allowed to spread unhindered. With so much access to free information, even unwilling participants accessory to such crimes would be able to anonymously spread the word.

Which leaves the EU in its current form of stifling, undemocratic processes. And one has to wonder, “what’s the point of this?”

The EU is predominantly about the euro, which is the second layer of trouble. The modern welfare state also evolved in response to the end of the World Wars; a period of time when starvation and economic poverty was running rampant across war torn nations and when modern political movements were asking how they could avoid letting events like that ever replay themselves. The proposed solution was to directly aid citizens, which would have the secondary effect of giving everyone an incentive not to participate in forms of political upheaval or risk losing those benefits.

But the heart of the welfare state is a type of nationalism; open borders and free moving populations make for trouble when trying to run national benefits.

Which makes it so odd that welfare states in the 90’s decided to adopt a common currency that they have no direct control over. The welfare state de facto playbook is to address any inevitable economic stagnation, recession or depression with new economic equilibrium, rather than economic reform. The entire point of practical political welfare is to entrench interests of a political majority and avoid challenges. The other guys get to deal with economic variability. See public sector labor unions for an idea of how that works.

By switching to the euro, perhaps unknowingly, the welfare state model sold out its most powerful tool to achieve that outcome. Modern problems are very much a product of adopting the euro. Pro-welfare commentators in the media take it a step further by pinning the fault of those problems on the euro as well. That belies a bias towards a welfare model of government. You could easily argue that the welfare model is itself the problem and that the euro was just a monumentally stupid strategic move on the part of the major players. In either case, the common currency without political union is causing fissures to form across Europe, for the better part of 5 years now. We’ve sort of beat this theme to death by now, so I’ll cut more commentary short here.

And so now, in 2015, we have the president of France actually considering a political union with old cultural enemies Germany and the UK, and Greece immediately trying to undo the effects of a referendum they themselves wanted to have. It’s almost preposterous, if not for the desire to preserve the welfare programs. That’s the only driving force holding this thing together at this point.

So on a warm weekend in July, Francois Hollande is making a last ditch and desperate appeal that amounts to selling out everything French about France, just to avoid the discomfort of some relatively modest cuts and the bravery required to trust his own citizens.

You have to wonder if even Friedman would have seen that coming.

In short order, as the euro collapses towards dollar parity, this call will be picked up by the globalists here in the US as well. It will be their one chance, for perhaps hundreds of years, to stitch the US into the European framework. God willing we crush them without much trouble when that happens.

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Oil Markets Are Destroying Themselves

We’re still in the midst of watching the oil industry unravel in spectacular fashion. I do not feel comfortable even uttering the word “bottom”, not even in jest, for the fear the entire structure would unwind and usher in $10 oil for two decades.

We need more expensive oil. I know you do not want to hear that; why just a few weeks ago I saw a long dormant Hummer H3 roaming the tundra planes of southeast Michigan. A once formidable species, these vehicles could once be seen all across the North American continent.

Their reemergence was a startling sign. Gasoline has gotten cheap.

It is comforting to think of these lower input costs as an unchallenged blessing to America. It is more complicated than that, I am afraid.

High oil prices have been one of very few elements that has actually helped foster stability in third world countries. Watching the recent turmoil and wars, it is easy to forget just how unnaturally peaceful the most recent decades have been in the grand scheme of things. Oil money has been used to weave the social fabric in these places and if oil prices stay low for a sustained period, we are going to see much more egregious cases of foreign sovereign collapse.

Oil prices have also driven the US recovery. The shale revolution was named thusly for a reason; job growth in the US would not have been possible without the advances in shale oil. This is a major pillar of the US recovery and without it our economy is going to suffer. High input costs were a minor inconvenience that came with job growth.

And of course there is the euro. The euro may just be the cause of the oil collapse in and of itself. I cannot say for certain yet, but I am suspicious. The euro and dollar are now almost at parity and this has crippled US exporters. If our own markets are suddenly sloshing around with oil to spare, it is because we are suddenly priced out of foreign markets. This is a precarious barrier…how cheap would oil need to be in this country to enable exporters to compete against euro/dollar parity? The dollar is going to isolate our business and tank us if we let this continue.

We need to start taking steps to regain stability. Bernanke would have never let this happen. Yellen is pushing for normalization of policy and this is not a bad thing. But they are far too comfortable watching a currency move like this happen with our probably largest trade group. We need a weaker dollar and we need more expensive oil and we need it now.

Now, because oil is so cheap, struggling shale producers are clocking overtime to meet payments. This is the exact opposite of what the oil markets need to find a bottom – a glut of even more oil.

In addition to addressing currency and demand issues, we really need a JP Morgan figure to emerge and start brokering some M&A moves that stitch up the supply side. Oil markets are leaking supply uncontrollably and this is going to cause extensive damage if not treated like the dire risk that it is.

The weak hands need to be either bought out or flushed or secured with long term financing. If we can’t shut some of these wells off, we’re going to have irreparable damage on our hands.

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The Big Question Then: How To Play EU QE?

The Swiss bank just announced that the ceiling they have been maintaining against the euro is to be dropped. That would make sense, since the euro is now trading below 1.17, down from almost 1.40 just earlier. In terms of the exchange rate, that had to be getting very expensive.

But the timing here should be viewed as a sign that the ECB is really about to start QE. This should be the stance because if they don’t, the impact would be minimal, but if they do you can’t be on the wrong side of the trade.

In terms of what this QE will look like…well, that is the question. What is the ECB going to buy? Not public debt, surely. How much more financing can these governments stomach with yields already negative in many countries. Even the worst countries, like Greece, are borrowing at rates that an average citizen would envy.

My guess here is two fold: (1) they buy up private financial assets similar to the mortgage program the Fed had in place, but that it will center on short term bonds, while also working with banks to create a long term financing window (EU companies and banks in particular have notoriously short term financing arrangements) and (2) they take the opportunity to absorb whatever mechanisms exactly they have been using, before now, to hide the massive debt loads that should have been coming due over the past three years.

If you forgot, Europe ended up pulling some master BS, using a combination of trade accounts to gobble up the garbage so that the markets wouldn’t have to see it default. I’m hazy on the exact specifics, but I would gamble that those imbalanced accounts are still outstanding; and my guess is they’re about to get totally monetized.

So the big question now is, where do you park money? I think that it would be very stupid to try and be short right now with central banks making big noise and seemingly readying the cannons.

If this is like past central bank action, then any longs will do – equity, commodities, debt, whatever you like. Oil could get a huge boost since it’s been so ravaged. ECB action will give the Fed room to play, especially if deflation keeps up. Yellen is no Bernanke…yet, but she also hasn’t been tried either. If the Fed coordinates, all boats get lifted.

But the safest low key play is probably just to hug U.S. dollars until things are a little more clear.

I am ~78% cash, with positions in CCJ, BAS and VOC, down roughly 3% in the first two weeks of the year.

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Oil just got beat again when it became public that OPEC is a dysfunctional organization. Who could have imagined that disparate oil producing nations with deep, cultural differences (read racism) might have trouble working through competition?

I never would have guessed it would crop up this quickly. But the demise of OPEC is hardly unforeseen. I myself penned an article this July discussing the possibility of the oil markets being upended.

But it is funny, reading through those thoughts going on just five months old, and seeing how violently they have diverged from what I expected.

I expected the development of US oil and gas reserves would create trouble for the old guards. I did not expect that oil would collapse 30% in two months. While you could say that those price swings were to be expected – just simple economics – I had expected the US might actually do more legislatively to erect a wall between us and the oil nations altogether. Obviously this happened much too quickly for any of that.

I had also guessed that when things started to get tough, OPEC would at least try to band together first. They’ve been successful at this in the past, so failing to construct even symbolic production cuts this round is certainly worse off along than I would have ventured.

The fallout in oil and energy names, following August, is not something I truthfully believed in. This may sound strange, but I was actually betting against myself when I made those sales of my oil and gas positions. And I never would have believed we’d fall so far. BAS is off 60% peak to trough, for crying out loud. Even when I knew we were experiencing a correction, I didn’t think it would be this extreme.

Now let’s put some context into all of this. Some of these energy names are trading at prices as bad as or worse than they were in 2010-2011 (when oil prices were pretty much where they are now); and lots of these energy companies were losing money back then, whereas they are making money today. I’m talking about BAS explicitly as an example.

So what happens now?

Well, I think that the prices of oil & gas plays are pretty compelling here. Yes oil is a bummer and there is big talk about $30 oil being right around the corner. And it’s no coincidence that I think this talk is stupid and that those responsible should be viciously ridiculed. I think the price drop is temporary, unremarkable and indistinct from any other major selloff that has gripped the price of oil in the past five years.

I think competition will continue to do real damage to the major oil nations in the world bringing about the greatest power shift of our lifetimes. But as apart from my peers, who seem to believe that a Venezuela or Russia has the ability to ramp up production into this price drop, leading to a deflationary spiral that ushers in 1990’s prices for all Western nations, I tend to feel this is silly.

You can’t call for the death of the Bakkens and simultaneously think that oil stays this low. Actually I have a hypothesis that the events that would have to converge to keep oil this low are few and far between. The big question here is timing as to when oil goes higher.

So my guess – and this is definitely just that – is that the US shale boom lives. And here’s what will enable that to happen.

These oil exporting countries have all made brazen moves with their budgets. Places like Russia, Saudi Arabia, or Iran are barely holding it together. Places like Venezuela can’t even muster that; oil prices for Venezuela are kind of like mattresses or trampolines to a guy already falling off a roof – a point of hope.

But if oil prices keep falling, you’re going to see one of these places – and Venezuela is definitely near the top of my list – buckle. Venezuela is probably the easiest case to get back to $100 oil, because one Venezuela is good enough to offset new US production. But it could just as easily be a combination of other smaller oil exporters. A half dozen of the smaller to mid size guys, or even a combination of Syria and Iraq plunging back into darkness. IS is obviously a possible trigger here; a bunch of pissed off twenty year olds, armed with rocket propelled grenades, trying to operate oil machinery? Sounds like a nice, safe combo.

What we’ve seen, repeatedly, is that when a place like, oh, Syria or Libya plunges into anarchy, it’s not just a small setback. Rather, the entire oil infrastructure gets taken offline for years at a time.

Another civil war or resurgent fighting could easily get us back to lower oil production in these places. Some US legislative work (now freed from the concerns about access to supply thanks to the US domestic advances) could help keep our own oil expertise from setting those places back up again after they tumble.

Why would we want to do this? Rome is sick of Carthage.

Just think about the sheer number of problems that these countries have dealt us over the past fifty years. We already know that the US can withstand $100 oil. We’ve been doing it for a few years now. And $100 oil benefits the US economy directly, whereas $80 oil is the worst of all worlds; too cheap or expensive to care about.

With the GOP in Congress and looking to juice the US a little, and with Obama increasingly looking for a major win, sticking a stake in the middle east is probably the lowest hanging fruit around. Kill IS by letting them destroy their own oil infrastructure, then restrict the companies that have usually bailed that region back out (Shell, Exxon, etcetera) from doing that. Lower Russia back into 1993 conditions, then tell Blankfein to keep out this time.

That’s how I see things playing out. Sure we could watch the US shale revolution just go to waste completely. But I think at this junction the US has a pretty vested interest in not letting that happen. It’s a new dawn, after all.

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