West Texas Intermediate (WTI) oil for December delivery is currently priced at $75 per barrel, Brent for January delivery at $78 per barrel. Many investors, publications and news sources focus only on the drawbacks to falling oil and gas prices-don't get me wrong, there are many-but today we're going to give the spotlight to the biggest winners and beneficiaries.
Starting with your pocketbook.
Oil has slipped 30 percent since July, but the only place in the world where retail gas has fallen as much is Iran. In most countries, gas is down between 10 and 15 percent. Here in the U.S., ground zero of the recent energy boom, the national average has fallen close to 20 percent. As I said last week, American consumers have been treated to an unexpected tax break because of this slump, just in time for the holiday shopping season.
Three of the main contributors to oil's decline are the strong U.S. dollar, which has put pressure not only on oil but other commodities as well; geopolitics, specifically tensions with Russia and the Saudis' currency war; and the acceleration of American oil production. The hydraulic fracturing boom has flooded the market with shale oil, which in turn has driven prices down. As you can see below, there's a wider spread between 2008 and 2014 oil production levels in the U.S. than in any other oil-producing country shown here.
Which Countries Benefit?
Last month I briefly discussed how low crude prices benefit Asian markets the most because they tend to be net importers of oil and petroleum. On top of that, a large portion of the population in these countries spends a significant amount of their weekly income on gas-in the case of India, as much as 30 percent. The biggest winners, then, are Asian countries such as India, Philippines, Thailand and Indonesia
China, the world's largest net importer of oil, second only to the entire continent of Europe, also benefits. For every dollar that the price of oil drops, its economy saves about $2 billion annually. Even though it just signed a multibillion-dollar, multiyear gas supply deal with Russia, China plans on tapping into its own shale gas resources, estimated to be the largest in the world.
One notable exception to the Asian market is Singapore. Although the city-state is a net importer of crude, bringing in around 1.3 million barrels a day, it depends heavily on oil exports to grow its economy. According to Bloomberg, in fact, Singapore ranks second in the world for a reliance on crude, based on a change in oil exports as a percentage of GDP from 1993 to 2018. Only Libya's economy is more dependent.
Because the United States continues to be a net importer of crude and petroleum-it imports around 6.5 million barrels a day, according to CLSA-it has benefited as well, but its dependence on foreign oil is falling fast.
In the chart below you can see how breakeven prices increase as both global oil demand grows and the geological formation requires more sophisticated-and expensive-extraction methods.
Which Industries and Companies Have Benefited?
To answer this question, Strategic International Securities Research (SISR) ran a correlation coefficient between the retail price of gas and 72 global industry classification standard (GICS) sectors, focusing on the years 2000 through 2014. Below are the top three sectors that ended up benefiting the most from falling gas prices. They all have a negative correlation coefficient, meaning that their performance has historically gone in the opposite direction as the price of gas, similar to a seesaw.
What this data shows is that U.S. manufacturing industry has regained the cost benefit advantage to Chinese manufacturers. It's becoming more and more attractive to build and create here in the U.S. because the cost of energy is relatively low.
Leading the list is automakers, suggesting that when gas prices have dropped, consumers have felt more confident purchasing new cars and trucks. Today consumers are even returning to vehicles that are known to guzzle rather than sip gas, such as SUVs, pickup trucks and crossovers. Ford's F-Series continues to blow away its competition. Since mid-October, General Motors has delivered 7 percent, Ford 11 percent and Tesla, 12 percent.
It makes sense that airlines would perform better, since fuel is typically their largest single expenditure. In 2012, when the average price of a barrel of oil was $110, fuel accounted for 30 percent of airlines' annual operating costs. Low fuel costs are cited as the main reason why Virgin America, which went public today, reported third-quarter profits of $41.6 million, an increase of 24 percent year-over-year. The NYSE Arca Airline Index has flown up 110 percent since the beginning of 2013, hitting 13-year highs, and Morgan Stanley recently took a bullish position toward airline stocks, showing that company balance sheets are "structurally sound enough to make 'events' in the next five years unlikely" and that the industry as a whole is now growth-oriented.
It also makes sense that aluminum would benefit, given that the metal requires a notoriously large amount of energy to produce.
SISR highlights a few industries that surprisingly have had a positive correlation coefficient: department stores, apparel retail and luxury goods. You'd think it would be safe to assume that the retail sector benefits when consumers have been given relief from high gas prices. This is certainly the case now: Walmart, a bellwether for general market sentiment, is hitting new highs, and Tiffany & Co. is also thriving. But in the past, low oil and gas prices have been reflections of a weak domestic economy. The average price per barrel of crude in 2009 was $62, a sharp decrease of nearly 40 percent from the average in 2008. Today, gas is inexpensive not because the economy is weak but because frackers are simply too good at what they do. They're victims of their own success. What has hurt them has helped American consumers build more disposable cash flows, which can now be spent on fast food, retail, home improvement and other goods and services.
OPEC Unlikely to Make Production Cuts, Consensus Says
Members of the Organization of the Petroleum Exporting Countries (OPEC) will be meeting on the 27th, and no doubt the discussion will center on whether to curb production to help oil prices recover. However, a new poll shows that commodity and energy investors do not believe such a cut will occur. According to BMO Capital Markets, 87 percent of those polled believed that no cut would be agreed on. Even those who said a cut would happen believed it would be no more than a million barrels a day, an insignificant amount.
Of course, this is merely a poll, but we might be looking at cheap oil and gas for an indefinite amount of time, with a bottom possibly reached sometime between now and February.
In the meantime, American producers will continue to pour out record levels of oil, and President Vladimir Putin's antics in Ukraine will continue to stir up geopolitical tension. Saudi Arabia appears to be more aligned with Europe and the U.S. against Russia, Syria and Iran.
All of this short-term activity might be bad for the fracking industry, but the big winners are consumers and investors. We're in a steady, modest expansion of our economy and this is good for investing in domestic stocks.
- Major market indices finished higher this week. The Dow Jones Industrial Average rose 0.35 percent. The S&P 500 Stock Index gained 0.39 percent, while the Nasdaq Composite advanced 1.21 percent. The Russell 2000 small capitalization index rose 0.06 percent this week.
- The Hang Seng Composite rose 2.42 percent; Taiwan rose 0.79 percent and the KOSPI rose 0.27 percent.
- The 10-year Treasury bond yield rose this week to 0.96 percent.
Domestic Equity Market
The S&P 500 was positive again this week, rising 0.39 percent. After two weeks without quantitative easing (QE) assistance from the Federal Reserve, it seems as though the short-term trend remains positive overall.
- The telecommunications sector performed the strongest this week, with AT&T and Verizon both top performers, up over 2.81 percent and 1.24 percent, respectively. This comes on the heels of president Obama’s comments of a desire for “net neutrality,” as AT&T ceased construction of its high-speed data network until net neutrality has been ruled out.
- Consumer discretionary also performed well, up over 1.7 percent for the week. Amazon led the group up 9.32 percent, followed by Priceline up 7.16 percent. Also included in the sector was Fossil Group which was up 5.15 percent. A key driver in this sector is falling energy costs which help put money in the pockets of consumers. Consumers spent their new savings on desired as well as needed items, or on vacations.
- Baker Hughes was the best performing stock in the S&P 500 this week, rising 14.61 percent. The company announced its discussions with Halliburton for a potential acquisition. Halliburton also rose on the news, up 2.30 percent this week.
- The utilities sector was the worst performer this week, following 15 days of strong performance. Nearly all of its constituents were negative, with the worst performer NRG Energy down 7.5 percent.
- Another area of weakness was energy, affected by companies such as Helmerich & Payne, down 8.9 percent on poor earnings and falling commodity prices. Southwestern Energy was down 7.53 percent, mostly due to falling oil and natural gas prices.
- The worst performing company this week was Transocean, which fell 12.25 percent as the company missed expectations, took large one-time charges, and was affected by falling oil prices as well.
- The G20 Summit is this weekend in Australia and could provide the market with some encouraging comments from member nations to help spur growth.
- Next week a few important economic data points will be released including New York state manufacturing, which is expected to be double the previous months, as well as consumer price index (CPI) numbers and October home sales.
- The largest European countries (Germany, France and the United Kingdom) narrowly missed a recession this week, which may help bolster market confidence in the region.
- Market momentum seems to be flattening, and possibly not to the consensus of recovery expectations, therefore causing fear amongst investors.
- After Russia stole the spotlight at the Asia Summit this week, one can only imagine what the country might attempt to do at the G20 Summit to help bolster its fledgling commodity-driven economy.
- With the tensions in Ukraine on the rise again, and constant saber-rattling from current, future and former superpowers, one can speculate the tightrope that politicians must tiptoe across to keep the global economy in recovery mode.
U.S. Treasury bond yields rose modestly this week as the stock market reached new highs. Economic data was not the big market driver this week. The market sold off on treasury supply concerns earlier in the week as the three-year note auction came in weaker than expected. Yields declined as the week moved forward, ending just a basis point or two higher than last week.
- October retail sales rose 0.3 percent this week, and excluding automobiles and gasoline rose 0.6 percent. Falling gasoline prices should provide a lift for the consumer going into the holidays, making this a good start to the fourth quarter.
- According to Challenger, a placement firm, retailers hired at a record pace in October, adding 180,600 workers. This is up 13 percent from 2013 and comes in as the strongest number since records began in 1939.
- The U.S. Department of Labor reported that gross hiring rose to 5.03 million in September, the most since 2007, while “quits” rose to a six-year high on improving confidence in the job market.
- A slew of economic indicators in China disappointed this week as industrial production and retail sales both rose less than expected.
- The U.S. dollar has been strong for months and is likely poised for some retracement in the next few weeks.
- Economic data out of Europe was encouraging, but the absolute level of growth remains very meager.
- Global central banks are easing again, offsetting the incremental Federal Reserve tightening and remaining positive for fixed income globally.
- Short-term Treasury yields were relatively flat week-over-week but remain near the top end of the recent range. This may be an opportunity as yields could reverse course. The catalyst could be weak housing starts or industrial production data scheduled for release next week.
- Municipal bonds continue to look like an attractive alternative in the broad fixed-income universe.
- There was a fair amount of noise recently with regard to internal grumblings at the European Central Bank (ECB). If the ECB can’t or won’t follow through with additional policy measures, the market will not like that instability.
- Quantitative easing has ended and the next logical step would be an interest rate hike. While estimates of when that may occur remain fluid, the Fed’s relatively hawkish tone increases the risk to the bond market.
- The geopolitical situations in Ukraine heated up again this week and the potential for a misstep remains high. Potential fallout is difficult to predict.
November 12, 2014
Gold, Oil and the Currency War
November 12, 2014
Sit Back and Stay Balanced
November 11, 2014
Is Gold Clawing for a Bottom?
For the week, spot gold closed at $1,189.01 up $11.03 per ounce, or 0.94 percent. Gold stocks, as measured by the NYSE Arca Gold Miners Index, rose 2.94 percent. The U.S. Trade-Weighted Dollar Index fell 0.13 percent for the week.
|Nov 13||China Retail Sales YoY||11.6%||11.5%||11.6%|
|Nov 13||Germany CPI YoY||0.8%||0.8%||0.8%|
|Nov 14||US Initial Jobless Claims||280K||290K||278K|
|Nov 14||Eurozone Core CPI YoY||0.7%||0.7%||0.7%|
|Nov 18||US PPI Final Demand YoY||1.2%||--||1.6%|
|Nov 19||US Housing Starts||1025K||--||1017K|
|Nov 19||HSBC China Manufacturing PMI||50.2||--||50.4|
|Nov 20||US CPI YoY||1.6%||--||1.7%|
|Nov 20||US Initial Jobless Claims||284K||--||290K|
- Gold traders turned bullish for the first time in three weeks as prices neared four-year lows. Additionally, this month U.S. Mint gold coin sales are already more than half of what they were in October, which was the strongest month since January. Austria Mint sales are up 40 percent from October.
- Gold prices rallied on Friday as more than 10,000 contracts for December delivery were traded, pushing the gold price up 1.5 percent within six minutes. Moreover, the one-, two-, three- and six-month gold forward offered rates turned negative, signaling increased physical demand in a tightening market. Robin Winkler of Deutsche Bank wrote that current polling on the referendum in Switzerland (to require its national bank to hold 20 percent of its reserves in gold) was now leading in the polls.
- On Tuesday, gold futures jumped higher after a report showed that U.S. jobless claims increased more than forecast last week.
- The World Gold Council announced that gold demand fell to the lowest level in almost five years in the third quarter as bar, coin and jewelry purchases slowed.
- Silver shorts are at record highs as the market remains negative on the precious metals sector due to the strong U.S. dollar. Fund shorts account for 39 percent and 54 percent of total open interest for Comex silver and Nymex platinum, respectively.
- Switzerland’s regulator charged UBS AG employees with front-running in precious metals trading, particularly in silver, as part of its review of the bank’s foreign-exchange business. The Swiss regulator and those in the U.S. and the U.K. ordered UBS and four other banks to pay about $3.3 billion to settle a probe into the rigging of foreign-exchange rates.
- The UBS commodity strategy team published a contrarian report stating that liquidity will run dry well before the Federal Reserve has a chance to increase the Fed Funds rate, according to the research firm’s Proprietary U.S. Liquidity Indicator. As a consequence, they believe the next significant action of the Fed will be an attempt to reflate the U.S. economy, not rein it in. This leads to a bullish outlook on both dollar cash and gold equities.
- The same UBS report delineates that gold stocks will outperform bullion as the Fed likely reflates the economy. The research firm's Fed Action Model predicts when the Federal Reserve is likely to act when the reading falls below zero. Furthermore, their reasoning for gold stocks outperforming bullion is a result of two types of gold rallies. The first is a reflationary boom scenario where bullion outperforms gold stocks as commodity appreciation causes costs to rise. This leads miners to low grade operations and undertake high-cost expansions and M&As. That was the case in 2004 -2007 and 2009-2011. The second type of rally is characterized by risk aversion flows out of credit and equity and into treasuries. Costs at the mine fall as commodity currencies decline. Miners cut costs and restructure. With gold in a bear market, the stocks are financially and operationally geared. This was the case in 2001-2002 and during the last four months of 2008. This is the scenario the UBS team sees presently unfolding.
- Anita Soni of Credit Suisse believes gold mine production is likely to plateau in 2014 and decline over the medium term. This would be a tail impact of significant CAPEX from 2010-2012 that has now entered production and producer expenditures on growth capital. Gold mining exploration has also been cut. This supply shortage would push gold prices higher.
- India, the world’s biggest gold user after China, announced it will review bullion import rules after purchases in October jumped to the highest level this fiscal year. Though no indication has been given, any import restrictions could be a headwind for gold prices.
- The labor movement in South Africa has been thrown into turmoil after the November 8 decision by the Congress of South African Trade Unions to expel the National Union of Metalworkers of South Africa. The decision was opposed by seven of the 20 other affiliates and sets the stage for a fight over loyalty and membership dues of the remaining 1.85 million members. South Africa’s labor relations are the most hostile of 144 countries, according to the World Economic Forum, and the country had 114 strikes last year that resulted in 6.7 billion rand ($597 million) in lost wages.
- UBS cut its one-month gold target from $1,250 per ounce to $1,180 per ounce citing weak sentiment, light positioning and an extreme amount of shorts.
- Metals and mining stocks had a big comeback this week. Fears over a slowdown in global growth had depressed the metals space for the past few weeks, leading to oversold conditions. The S&P/TSX Capped Diversified Metals and Mining Index closed up 2.52 percent this week. Nevsun Resources rose 4.93 percent this week.
- Gold stocks continued their rally this week, despite falling oil prices stirring deflationary fears. The NYSE Arca Gold Miners Index rose 2.76 percent this week. Franco-Nevada closed up 3.92 percent this week.
- The International Energy Agency’s November report maintained previous demand estimates for 2014 and 2015. While the energy space has taken a substantial beating of late, the presence of strong demand may imply that the bottom is close.
- Oil and gas drilling stocks declined this week as the global energy sell-off continued. Declining oil prices continue to weigh on the industry, causing the S&P Supercomposite Oil & Gas Drilling Index to fall 7.48 percent
- Typically a brighter area of the energy space, oil and gas refining stocks fell this week as declining oil prices narrowed the spread between West Texas Intermediate (WTI) and Brent crude. The S&P Supercomposite Oil & Gas Refining & Marketing Index was down 2.67 percent this week.
- Utilities stocks saw their first weekly decline since the end of September this week, giving back some of their exceptional gains. The S&P 500 Utilities Sector fell 3.05 percent this week.
- While many are predicting an interest rate increase in the United States as early as mid-2015, some analysts are forecasting the next installment of quantitative easing, QE4. CLSA’s Greed and Fear argues that the two times the five-year breakeven inflation rate declined to 2 percent, the Federal Reserve began expanding its balance sheet. Currently, the five-year breakeven inflation rate is around 2.2 percent and trending lower. Fear of deflation could prompt further expansionary measures in the U.S., which would be positive for equities overall, particularly gold stocks.
- France's GDP grew for the first time this year during the third quarter, while Germany's growth remained positive. Given the headwinds facing the eurozone, the results are a relief to many investors and allow the European Central Bank (ECB) more breathing room for enacting its easing policies.
- The OPEC meeting at the end of this month could not be more pressing. With oil prices severely depressed and weighing on the exporters' budgets, a production cut could yield a significant boost to the energy space.
- Oil continued its downward trend this week, inciting new fears of further declines to come. If oil dips lower, many energy companies could find themselves in a dire situation. On a positive note, because demand remains strong globally, a decrease in supply will reveal the bottom for oil prices, which should bounce given the present severity of oversold conditions.
- The dollar seems to be unstoppable. After consolidating for a short period of time, the dollar has risen to new highs. The rise remains a warning sign of a weaker global economy and the threats that still exist to destabilize it.
- The Platts China Steel Sentiment Index revealed that expectations for new orders dropped from 71 in October to 33 in November. The results are the product of speculation that China is removing certain tax rebates on exports of steel products.
- Turkish stocks rallied this week, getting a boost from falling Brent prices. The country is a net importer of oil, which has allowed it to benefit in the current cheap oil environment. Turkey’s current account deficit shrank roughly 33 percent year-over-year in September, while the yield on two-year government notes fell to the lowest level since July. The Borsa Instanbul 100 Index closed up 4.17 percent for the week.
- Hungarian banks breathed a sigh of relief this week as the government decided to allow the conversion of $14 billion of retail foreign-currency mortgages at the market exchange rate. The government has been at odds with the banks after accusing the latter of unfair lending practices. The recent news comes as a sign of cooperation and solidarity. The Budapest Stock Exchange rose 1.51 percent this week.
- Both China and Hong Kong were among the best performing Asian countries this week, as the government set November 17 as the official start date for the Shanghai-Hong Kong market integration program. This will allow investors from both sides to trade stocks listed in each other’s exchanges after seven months of preparation.
- A great deal of attention was placed on Russia this week, and for good reason. The ruble saw its eighth-straight weekly decline as foreign sanctions, declining oil prices, and intolerably high borrowing costs continue to choke the country’s economy. Russia’s central bank has been using every tool at its disposal to prop up the ruble, even going as far as to limit domestic lending to the financial sector. Still, the ruble remains the worst performer out of more than 170 currencies, declining roughly 22 percent over the last three months. Furthermore, Russia escalated the conflict in Ukraine this week as NATO reported Russian troops and artillery amassing in eastern Ukraine. The reignited geopolitical risk alongside the continued pressures facing the Russian economy led the ruble to decline 0.8 percent against the dollar this week.
- Another currency that saw significant sell-offs this week was the Brazilian real, declining 1.11 percent against the dollar. The volatility surrounding Brazil stems from speculation over who the re-elected Dilma Rousseff will choose as the next finance minister. Furthermore, Petroleo Brasileiro fell 7.5 percent this week as the company considers the results of an internal investigation about money laundering and bribery. The Ibovespa Brasil Sao Paulo Stock Exchange Index fell 2.73 percent this week.
- Malaysia was the worst performing Asian country this week, as its third-quarter GDP slowed to 5.6 percent year-over-year from 6.5 percent in the second quarter largely due to deceleration in exports. The current account surplus declined significantly to 2.8 percent of GDP from 6.1 percent of GDP in the previous quarter.
- The substantial underperformance of Brazilian stocks has been cited as one of the main reasons for Morgan Stanley’s upgrade of Brazil from underweight to equal-weight this week. Technical indicators are revealing a much oversold condition in Brazil, perhaps providing a cheap buying opportunity according the report.
- Greece’s Deputy Finance Minister, Giorgos Mavraganis, announced plans this week to improve the country’s tax system and foster growth. The plan includes cutting the income tax rate for businesses, reducing the minimum tax rate on income-wage earners and pensioners, lowering the property tax rate, and developing harsher punishments for tax offenses.
- Chinese government policy efforts to stabilize the property market and rein in excessive local government borrowing should help reduce systemic risk and enhance the asset quality of Chinese banks over time. The imminent official start of the Shanghai-Hong Kong market integration program could be a near-term catalyst for re-rating as Chinese banks are still trading at near trough valuations despite consistent dividend growth in the last eight years.
- Russia faces the threat of tougher sanctions due to recent allegations of providing weapons and artillery to rebel forces in Ukraine. Current sanctions have already placed significant pressure on the economy, which saw growth of only 0.7 percent in the third quarter. Furthermore, many speculate the central bank will enact another rate increase to defend the ruble, which would be the fifth rate hike this year. Higher borrowing costs for domestic banks, which had its access to credit cut by the central bank this week, could serve to hurl the Russian economy into a recession, a possibility Putin and the central bank are very much aware of.
- The dollar’s continued climb remains a warning sign to the global economy. While the eurozone has by and large avoided another recession, deflationary pressures and global growth scares continue to dominate market sentiment. While a reversal of the dollar is certainly overdue, the catalyst that would cause it has yet to be found.
- A number of things may continue to weigh on investor sentiment towards South Korean equities including: (1) increasingly challenging exports, pressured by a stronger Korean won versus the Japanese yen; (2) negative earnings revisions; and (3) a price-to-earnings valuation above the decade average.
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