Friday provided a good test of the blog’s analysis that Japan’s aggressive policy of devaluing the yen could result in major downward pressure on crude oil prices:
• The yen crashed through the $1: ¥100 level, ending at a 4-year low of $1: ¥101.6
• Brent sold off by $2.80/bbl, only recovering after Asian markets closed for the weekend
Hedge funds have already woken up to the new profit potential that is developing. Thus Bloomberg reported the head of one large New York fund commenting “the inverse correlation between the dollar and the commodities is alive and well“.
The chart shows the 180 degree change that has taken place since March:
• Until then, all the main financial markets had continued to move together, in the ‘correlation trade‘ financed by western central bank liquidity
• But then the potential impact of Japan’s devaluation policy became obvious to major players
• A lower yen means a stronger US$ – hence no need to buy commodities as a ‘store of value‘
• Today Brent (blue line) and naphtha (black) are both down over 5%, whilst the dollar/yen (orange) and S&P 500 (purple) have risen over 10%
As Mizuho Securities noted, “commodities are taking a hit because the dollar is rising”.
Of course, it is still too early to be sure that crude will indeed crash out of its current trading range and revert to historical price levels below $30/bbl. Equally, markets never move in straight lines, downwards or upwards. But if one waits for proof, it could well be too late to do anything about it, as the blog warns in its new Research Note.
Critically, however, in terms of the fundamentals, US oil inventories remain at 82-year highs and supply is at 21-year highs: whilst forecast global demand growth this year is just 800kbpd.
Two other highly relevant points have also surfaced in recent days:
• Prof Martin Feldstein, President Reagan’s economics head, has called the Federal Reserve’s liquidity programme “a dead end“. He calculates its $2tn of new debt has raised consumer spending by less than 0.3% of GDP per year, adding that “the evidence suggests that the QE programme hasn’t worked“
• At the same time, the IMF has warned that US pension funds have piled into commodities and other risky assets in a desperate “gamble for resurrection“. It estimates their current shortfall at 28% – meaning they do not have enough reserves to pay current pension obligations. And it adds their issue is “solvency not liquidity“
Naïve pension fund trustees have thought ‘investments’ in crude oil and other commodities would enable them to avoid raising contribution rates or restructuring benefits. If prices now start to fall, they will have no alternative but to sell quickly, at whatever price is available in the market, in order to salvage what they can.
Meanwhile in Europe, further evidence of the impact of today’s failed policies in the real world emerged with the announcement of a proposed merger by INEOS and Solvay, Europe’s two largest PVC producers. This follows a 30% fall in PVC demand, and Kem One’s entry into administration in March. When first-class management teams like these are struggling, markets are clearly in very bad shape.
Benchmark price movements since the IeC Downturn Monitor’s April 2011 launch, and latest ICIS pricing comments are below:
Naphtha Europe, down 25%. “The prompt naphtha market has become balanced as a result of the 1 million tonne movement to Asia”
PTA China, down 21%. “Market outlook remains uncertain because of the volatility in crude futures and uncertainties over China’s manufacturing sector”
Brent crude oil, down 18%
HDPE USA export, down 17%. “Global export demand remained somewhat soft”
Benzene NWE, up 6%. “Prices ebbed and flowed alongside crude and benzene values in Asia and the US”
S&P 500 stock market index, up 20%