Friday, 7 August 2015

Commodity dumps, rate rises?

When I wrote two day ago that I was concerned that credit and leveraged tech could be on for a walloping I really didn't expect you all to read that and smash the market the following open, But thank you. At this point I should publish a book and set up a hedge fund beginning with P and appear on CNBC every lunchtime because it is obvious that I am a guru and we can all ignore the fact that most of my calls are rubbish and I happen to have got lucky for once. It works for many 'gurus' out there so why not me.

The last bit of luck I had was back on March 17th when I wrote a post  here suggesting that oil would base that day using clues in oil stocks.  Luckily it did and it has taken 5 months to get back down to the levels seen then.

The psychology of oil prices feels very much Elliot 3rd wave, and 3rd waves are meant to drive to lows well below the wave 1 low, yet there has been an overwhelming capitulatory mood for the last couple of weeks. Supply supply supply. The story has even gone 'Ambrose Evans Prichard', with him moving on from Europe to waving his 'end of the world is nigh' banner over Saudi Arabia.

But now price actions are beginning to suggest another base may be in place. Yesterday saw dramatic falls in my dodgy oil stocks that  looked capitulatory. But more interestingly the price action this morning is reflecting the pattern I last saw on March 17th with the stocks putting in healthy bounces.

Premier Oil vs Brent 

BP vs Brent 

Tullow vs brent 

So, I am trading my luck from the credit /tech call and doubling up for a call on a base (for now) on oil.

Now call me old fashioned, but one thing I am having problems tallying in my brain is how we can have an environment of strong enough growth to produce interest rate rises yet weak enough growth to crater commodities. I know that there are ways we can explain it, but the explanations feel too complex. I am looking for a simple Grand Unification Theory formula of e=mc^2 simplicity, not the complexity of the proof of Fermat's last theorem which has to invoke jungle treks through diverse mathematical fields.

On the commodity side we have China and EM demand falling matched by increased supply (as @georgepearkes beat me up over). On the rates side we can say (as @M_C_Klein of the  FT's Alphaville team kindly reminded me)  that the US move is not inflation expecting but just normalisation. All true, but I still find it hard to marry the basics. If we have strong enough growth to justify rate rises then we shouldn't be seeing cataclysmic commodity sell offs. Either commodities are going to bounce from or we are heading for a Greenspan rate moment.

By the time you read this we will probably have had US NFPs,  seen as the last clue for Sept US rate action, but I am completely bored by them.



Robert in Chicago said...

Hi Polemics,

I enjoyed you on Team Macro Man and was lucky to run across your new blog soon after you started. Some day we should connect personally, I probably already know a connection between us.

For some reason even economically literate people, who understand in the academic sense that price levels are a function of both supply and demand, focus overwhelmingly and far too much on the demand side. Your extended question makes that mistake. China just went through the biggest infrastructure build in global history and is now building less. That boom caused a massive, massive increase in supply for most commodities. The new supply would be tanking prices even if demand had stayed steady; the fact that China demand for commodities is already slowing merely adds to declines that would be large anyway. To take the one whose details I know best, iron ore, producers have already added hundreds of millions of tons of new capacity in the last few years and will add hundreds of millions more this year and over the next two. With oil, U.S. shale producers added almost a new Saudi Arabia over the last 10 years, and then what finally toppled the price was the unexpectedly robust recovery in production last summer/fall from several dodgy producers -- Libya, Nigeria, Iraq. Most other commodities also had big capacity expansions that were dumb from an industry perspective even under optimistic China demand assumptions. That is how commodity industries work. Similarly, most people finally figured out to stop screaming about the Baltic Dry Index's crash as a harbinger of doom. People built way, way too many new ships, end of story.

On the next level down of nuance, China's slowing demand for commodities would not NECESSARILY mean a big slowdown in overall economic growth. Their plan for years has been to shift that growth away from infrastructure and towards consumption. (As it turns out, overall growth has slowed more than they want.)

Next level: I don't think it's far from E=MC2 simplicity to say that the Fed can hike even though China growth is poor because U.S. growth is pretty good and the Fed sets U.S. not global rates.

Polemic said...

Robert, thank you so much for that and I would welcome a mail to so we can indeed connect personally.

I do agree with what you have said. The background for oil and china, the supply side oversupply - don't get me wrong I was fighting the Aussie hubris of never ending demand from 2006, through the GFC ( as they like to call it) and onwards. I have sat through countless meetings with Aussie strategists in those years proclaiming how Pluto and Gorgon were going to pipe Nat Gas to an ever ending Asian demand and how iron was going to be bought until the whole of China is covered with rail track. So yes I fully get the supply oversupply side. I also get the US vs EM/China differentiator re cyclical differences and the US that feed to monetary differences.And yes, I have oft cited the BDIY nonsense via the other side of the equation of Korean ship deliveries.

But but but... how long have we known this and how long have the basics of that meme been priced. I suppose as someone who has been screaming it for 5 years I assume that everyone else must have been on it for as long and so we are getting to the extreme of story /positioning/price.

Yes the US is only normalising with regards to rates, and they don't set for the rest of the world. But EM is pricing as if they do and it was only Jan 2014 when that cry of US rates dominating global funding was crucifying EM. They may well not set for the World but their impact does. If they go through a Greenspan moment and crank ahead of time (not saying that sept will be such .. but could be through global feedback loops) then it really won't be just them effected.

So in summary, .. yes to all your points but how much is priced into that theme I would suggest loads. We have been selling on the supply side for a while and yes, ultimately oil is the whale oil market of the late 1800s and the world is racing to open the taps on what is, despite recent supply glut, a finite resource, but I am solidly aware that growth NORMALLY runs hand in hand with commodity demand, even if its tosh speculative 2006-2012 demand. Now whether that demand in growth is global or regional (re US rates) is the question but despite all of us trying to segregate it, the world is linked more than ever and spill over counts.

Sorry for the long one after a good lunch .. but look forward to your mail

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