NOVEMBER 2014 INVESTMENT JOURNAL: CRUDE CRUSHED
- Republicans score big in U.S. mid-term elections
- Oil prices tumble
- Gold pricing set to move to the digital age
- Black Friday disappoints
(NOTE: We've included a "Quick Link" this month to an excellent article on personal tax planning published each year at this time by the American Association of Individual Investors. It's always among the best summaries we find about coming year tax code changes and strategies. Feel free to pass on to family, friends, and colleagues.)
The U.S. stock market led all other major asset classes in November with a 2.7% gain, even as international markets were flat to down for the month. Bonds continued to show positive results during November, which has been a surprise to most market participants this year. The big story in November was in the commodities space. Gold moved deeper into negative territory during the month, and oil plunged 13.5% just during the last week:
The current gap between broad commodity performance and stocks is at its widest point in over a decade:
With commodities down 17% over the last 5 years and U.S. stocks returning 108.6%, investors are beginning to wonder if the pendulum will ever begin to swing the other way. With so many having given up on commodities altogether, conditions are right for a classic reversal of fortune, and investors may look back at this past month as the beginning of the final "capitulation" phase.
Early in the month, U.S. mid-term elections saw Republicans gaining back control of the U.S. Senate, and scoring further gains in the U.S. House and the states. Most observers were surprised by the results, blaming lack of Democratic turnout for the losses. Investors immediately began factoring in "who wins and who loses" under the new regime. The general consensus out of the gate is that energy and utility companies will benefit from a lighter regulatory burden, while the defense industry will be boosted by a renewed commitment to military spending.
Things were quiet until mid-month, when tumbling oil prices shook up the markets. Momentum shifted dramatically to the downside as sellers overwhelmed buyers:
There are many theories as to why oil is slumping. A popular explanation is that U.S. shale (tight) oil production is surging, thus glutting the market:
Source: U.S. Energy Information Administration
However, all of that production is stored and consumed domestically, since the U.S. still does not permit exports of domestic oil (but the decades old ban may be lifted with the new Congress). So energy investors keep an eye on both the U.S. oil price (known as WTI, or West Texas Intermediate), and Brent (for ex-U.S. prices) to look for anomalies. Both prices tend to track closely, but the relatively recent boom in North American production (which has now placed the United States above Saudi Arabia as the world's most prolific producer) is a paradigm shift that has many wondering if sharper price divergences lie ahead:
Another theory has it that global demand is weakening, and is being anticipated by lower oil prices (a replay of the summer of 2008?). If that is so, we've got a big slowdown coming.
However, a more realistic explanation for oil's slump is due to Saudi Arabia's decision to use their cartel muscle to lower prices as a means of forcing U.S. shale producers out of business. (OPEC agreed late last month not to cut output to shore up prices, about as firm a statement one can make about preferring lower prices without actually saying it).
It's a giant political gamble that the U.S. seems to be tolerating for now, since it is putting enormous pressure on Czar Putin and Russia. However, the unintended consequences loom large, as ruling regimes in other Arab countries are being squeezed too, providing openings for further ISIS inroads. For a must-read look at this story from the always insightful UK Telegraph's Ambrose Evans-Pritchard, you can go here:
Russia is particularly vulnerable to a prolonged oil price slump, as its economy derives over half its revenues from oil and gas extraction. It is no surprise, then, that the ruble has been hurt badly by the drop in crude prices (as have all commodity-based countries like Nigeria and Malaysia):
Russia had already been struggling with Western sanctions over its annexation of Crimea, so the drop in export revenues was just starting to bite, and now along comes "the other shoe". The sinking ruble also has the pernicious effect of raising the cost of debt service (many of their interest payments are in US Dollars and Euros), so Moscow must use more of the ever shrinking ruble to buy the same amount of foreign currency.
In short, it's a triple whammy for a country that has seen a resurgence of nationalism, especially after world leaders publicly shunned Putin recently at the G20 meeting in Australia. For now, Moscow is now back-tracking on its decision to let the ruble "free float", and most observers expect them to begin intervening in currency markets to support the ruble. Ironically, that probably means they will have to sell off some of their gold reserves, which they have been assiduously accumulating during the good times of higher oil prices.
Geopolitically, it's another story. As we write this, Putin has announced plans to scrap the South Stream oil pipeline plan to transport Russian crude to Western Europe (payback for sanctions?). Instead, Russia has announced a partnership with longtime NATO ally Turkey to send crude there for further export, thus reasserting Russia in this key region at a time when Turkish leaders are leaning distinctly Islamist. When viewed together with last month's announcement that China and Russia have entered into decades long energy supply agreements, it is clear that major changes are taking place on the global energy chessboard. This will be a game worth watching (and, unfortunately, many of the world's chess masters have been Russian!).
Elsewhere, a story that got little attention was the announcement of a new online auction pricing system for gold. By way of background, the price of gold has been "fixed" twice each day since September 1919 by a limited number of banks in London based on their "best efforts" at price discovery. Unfortunately, the LIBOR rate rigging scandals of recent years have highlighted collusion among banks, leading to widespread mistrust of their motives to accurately set prices. Regulators increased their scrutiny to the point where all of the banks involved opted out of the responsibility of setting prices for gold.
Now, Intercontinental Exchange (ICE), a vast global electronic markets operator, has announced an updated digital version of the auction system for gold, where bids and offers in multiple currencies will be viewed in real time, with price updates every 30 seconds, effective in the first quarter of the new year. The idea is that transparency will be increased since there are a greater number of participants, and the use of an electronic gold fix should allow submissions to be more easily traceable in hopes of preventing manipulation. It is an encouraging development in our view, despite "dark pools" and other off-exchange traded platforms where manipulators can still be found (and always will, as long as the potential for profit exists).
Finally, U.S. shoppers apparently used the internet for more of their holiday shopping, as retail store sales over the Black Friday weekend slumped 11% versus last year. While analysts fretted over the reasons why, we're pretty sure that a growing number of sensible shoppers don't need much excuse to avoid the hordes at Wal-Mart, especially when prices and selections are better online.
That's a wrap for this month. Here's hoping your stockings are stuffed and Santa treats you and yours well - Happy Holidays Everyone!
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