Originally published by Chamber of Merchants
OPEC Makes a Deal
(Is crude a good idea now?)
From Fortune
Crude Oil prices–and the shares of US oil and gas companies–surged over 8% Wednesday as the Organization of Petroleum Exporting Countries (OPEC) agreed to cut its output by some 1.2 million barrels a day to end a global glut.
If fully implemented, the deal will effectively end the price war started by Saudi Arabia two years ago in its efforts to wrest market share back from U.S., a ploy that has wrecked the budgets of many OPEC members including Saudi itself.
Crucially, the deal is dependent on persuading major non-OPEC producers such as Russia to cut output too, by a total of 600,000 barrels a day. Moscow, having previously said it would only freeze production at current (record high) levels, has now committed to cut by 300,000 barrels a day, OPEC President and Qatari Energy Minister Mohammed Saleh al-Sada told a press conference in Vienna after the meeting.
Well that is fantastic. Well done guys. Your deal is keeping the oil price afloat and stock market…hates it.
Look at the last minute negative volume on the Dow Jones Industrial Average:
What’s going on?
This is a developing story. So for me to lay it out from start to finish would be foolish. What I can do is paint the picture and I’ll let you see what it looks like.
Firstly, the ADP employment numbers were great.
New jobs were better than expected. Except all the gains were concentrated in services: goods-producing categories like mining and manufacturing were negative. (I love quoting marketwatch…ugh) To me this is a simple one: Hiring and training of waiters, bar tenders, shelf packers etc all increase leading up to Christmas. That is what happens every year.(So it should be seasonally adjusted right?)
On the other hand, the Black Friday sales have failed to make new highs. This is reflected in the Personal Spending in the results above reported at 0.3%. Almost half of what was expected. Therefore lacklustre sales are to be expected.
In addition, pending home sales are running out of steam at 0.1%, half of what was expect and an entire plummet from the last month, although not many family homes are transacted over Christmas.
So what is the big deal?
The big deal here, is that while consumer spending is decreasing, the OPEC deal just lit a fire under inflation.
With an OPEC deal now reached, yet to be implemented, the bad inflation, has been given a new breath of life. Why bad inflation?
The main issue so far has been productivity, wage growth, consumer spending, GDP (without the soya beans please) and now the rising dollar. It culminates into a slow economic growth. Most economists expect the 4th quarter GDP numbers to be disappointing. So the Fed is trying its best to stimulate the economy while keeping the bond market from bursting.
Why would the bond market burst? Inflation. Yields increase and bond prices decrease as bond investors demand more bang for their buck if inflation is going to erode their returns over the lifetime of the bond.
What the Fed has been doing is buying bonds like crazy ($30 billion per day is pretty crazy) to keep bond yields under control and the prices and demand of bonds up.
This is especially important since the US Government raises money to pay debt from two main sources: Taxes (which are about to be cut) and Bond sales (which are dropping in prices since nobody wants them).
So if the demand for Bonds decrease due to inflation risk, then the government would struggle to borrow money to pay their debt (unbelievable I know.)
They would need to increase the yields (interest rates) which would affect the mortgage and credit market. Essentially, higher yields are higher interest rates.
Enter OPEC.
Everything was fine and dandy until yesterday’s OPEC deal.
You see, low crude prices are the only factor keeping inflation in check. With the hard slog to kickstart the economy, the last thing it needs is higher crude prices.
Higher crude prices act as a tax: every single household pays more for fuel. Not only that, but food and goods in general become more expensive as delivery prices increase etc.
So crude price increases bring bad inflation. It does not form part of the the Fed’s 2% inflation target. It shows up in the same number, but increasing inflation which is due to increasing costs and not demand is a big, big problem.
It’s called Stagflation.
Stagflation is a situation in which the inflation rate is high, the economic growth rate slows, and unemployment remains steadily high. It raises a dilemma for economic policy, since actions designed to lower inflation may exacerbate unemployment, and vice versa.
Now… does the stock market reaction make more sense now on the “good news” of an OPEC deal?
If inflation overshoots then the Fed will be forced to raise rates, several times.
Yet, if they raise rates it will contract the economy.
Not only that, but mortgages that have been barely serviceable at low interest rates will become difficult to manage for households that cannot manage to find good quality jobs or even full time jobs.
Stay tuned. This is going to get messy.
Gold & Dollar
Gold took a hit on the great ADP news as the dollar rocketed again.
However the “hit” should have been much much worse since the dollar did this:
Gold bounced off the $1173 mark again and and is sitting around there. I believed we witnessed the bottom in Gold yesterday and the support in Gold seems to be holding up, however we are back down at $1173-$1174 which is not great because if price keeps hugging a support zone it tends to break through after one too many hugs.
Stop losses will save you from a break to the downside. I previously mentioned that a stop around $1168 would be wise in case we get the next drop to $1143.
However, the wall of worry growing around the stock market and possible the bond market is growing. The CBOE Volatility Index increased by 3%:
This could also be due to the recovery in the bond market being short-lived due to increased inflation risks:
Especially worrying is the negative volume in the last 15 minutes of trade. Bond holders want out.
Conclusion
A storm is brewing.
Hang on tight because the “record highs” of the Dow Jones Industrial Average, S&P 500 and Nasdaq 100 are feeling the pressure.
Gold is one of the best hedges against inflation, but the interest rate hike promise is keeping a lid on its movement.
At this moment I am still all in on Gold and Silver, on the probability of a repeat of last year’s rate hike pattern.
Remember, Remember the 14th of December.
(also the 4th and the 6th…)