By William Patalon III
Money Morning/The Money Map Report
Analysts are trumpeting the recent drop in oil prices as a step toward normalcy. But is this celebration premature? Or perhaps even misplaced?
After all, we all know that over the long haul, energy prices are headed in only one direction – higher.
Crude oil plunged 8% to close at $106.23 a barrel last week – reaching its lowest level in five months – as the U.S. dollar strengthened to its highest point against the European euro so far this year. Crude oil prices actually declined for six straight days – the longest stretch since they did so from April 30, 2007 to May 7, 2007.
dropped 3.5% during the past four weeks. And unemployment spiked much more than economists had predicted.
Even so, oil prices are still 41% higher than they were a year ago.
"Demand destruction and the strength of the dollar are tailor-made to send oil prices lower," Daniel Flynn, a broker with Alaron Trading Corp. in Chicago, told Bloomberg News. "If it weren't for the active hurricane season, prices would be below $100."
Investors looking to hedge against the dollar's decline earlier this year helped lead crude oil, gold, corn and gasoline to records. The situation reversed over the past month as the dollar rallied against the euro.
But the question now becomes: How will OPEC react?
The Organization of the Petroleum Exporting Countries, the cartel of 13 countries that supply 40% of the world's oil, are scheduled to meet tomorrow (Tuesday) in Vienna. Iran and Venezuela – two of the perennial wild cards – have called for supply reductions because crude prices have plunged 28% from the record peak of $147.27 reached July 11.
"I think there's a chance that next week could be very interesting because of the OPEC meeting," said Christopher Edmonds, the managing principal of FIG Partners Energy Research & Capital Group in Atlanta, told Bloomberg. "It doesn't look like OPEC will cut quotas, but they are likely to try to boost prices with rhetoric."
Typically, oil and gas prices decline after Labor Day as the return to school means families will be taking fewer vacations, while cooler temperatures translate into reduced energy demand.
The direction that oil prices take this time around, however, could be determined by Saudi Arabia, the world's largest oil producer and the cartel's key (most influential) player. Back in June and July, in an effort to blunt the soaring escalation in oil prices, Saudi Arabia opted to unilaterally boost its output by half a million barrels per day.
"Where Saudi Arabia is in this debate is crucially important – that's our lynch-pin," Jan Stuart, oil economist at UBS Securities LLC (UBS) in New York, said in a radio interview. Saudi King Abdullah "is on record [as] saying $100 [per barrel] is too high, but that was a little while ago. We don't know what the Saudis are ready to defend and we do know the Saudis are the ones that would have to do most of the production cutting."
No matter what happens to oil prices in the near term, the long-term outlook is clear: Over the longer term, oil and gasoline prices are going to rise.
Let's face it – they have to. We're talking Econ 101 here. Anytime you increase the demand for a commodity – and don't increase the supply – the price is going to head higher. And the oil that's in the ground now around the world is all that there is.
Emerging economies such as China and India will stoke global demand for oil, monopolizing supplies and forcing global petroleum prices higher.
No matter what happens in the interim, the long-term script is set – so invest accordingly.
Looking ahead to the rest of this week, the economic calendar initially appears light. Friday brings two key reports:
- Analysts expect August retail sales data to confirm lackluster consumer activity, though some are hopeful that parents used the last of those tax rebates for some late school shopping.
- And the August Producer Price Index (PPI) also will be over-analyzed as investors determine how declining energy costs will impact the overall inflation picture. The core data may not yet reflect lower oil and gas prices working their ways through other sectors of the economy. (Bear in mind, many economists prefer to focus more on the core numbers, which exclude the volatile food-and-energy prices).
U.S. Federal Reserve policymakers are set to meet again on Sept. 16, so pundits will begin prognosticating in earnest, though most expect central bank policymakers to follow the lead of the European central bankers and stand pat on interest rates.
Last week had the potential to be a "perfect storm" for stock-market bulls.
Hurricane Gustav had very little significant impact on energy platforms in the Gulf and most cities suffered little more than some wind, rain and power outages. Commodity prices continued their freefall and consumers soon should have a few extra bucks in their pockets (in time for the holidays) as gas and food become more affordable. Republicans – historically the party of Wall Street – kicked off their political pep rally with a one-time Democratic leader (turned attack dog) bashing the opposition and a self-described hockey mom rejuvenating the base. Even so, the euphoria never came as some weaker-than-expected economic releases (see below) brought the bears out of hibernation.
Once Gustav was out of the picture (for the most part), oil resumed its decline. A stronger dollar and prospects for weaker global demand have contributed to the dramatic price reversal. Other commodities followed suit as gold, copper, aluminum and steel have experienced similar fates, leading to mixed expectations about the ultimate impact on the domestic economy. On one hand, the lower raw material prices could prove positive for consumers and businesses alike as they lead to lower inflationary fears and the manufacturing of more affordable goods and services. On the other hand, the price plunge could signify lower demand for such goods and services and the stronger dollar makes exports to our global trading partners more expensive at a time when they, too, are struggling. While both scenarios have merit, diminishing inflation should be well received at home and could make the Fed's challenging job much easier down the road.
Then there's the financial-services sector. While some analysts expect financials to rebound from their credit-crisis-induced Ice Age, the news of the week gave little indication that the worst is behind them. Goldman Sachs Group Inc. (GS) lowered its rating on Merrill Lynch & Co. Inc. (MER) to "Sell," on the belief that more write-downs (as if $5.7 billion was not enough) were in the cards. Ospraie Management LP closed one of its primary hedge funds, as some bad calls on commodities resulted in almost a 40% decline in the fund's value. In fact, hedge funds, in general, are moving more and more out of favor. According to the Hedge Fund Research Inc., during the first six months of the year, only $29 billion in new dollars flowed into these non-traditional assets, compared to almost $120 billion over the same period in 2007. Lehman Brothers Holdings Inc. (LEH) is still attracting suitors; with Korea Development Bank and possibly HSBC Holdings PLC (ADR: HBC) seem to be among the more interested parties.
The auto sector continued its struggles with General Motors Corp. (GM) (-20%), Ford Motor Co. (F) (-27%) and Toyota Motor Corp. (ADR: TM) (-9.4%) all reporting sluggish sales. Troubling retail and labor data (see below) caused major fears about the economy to resurface. As is often the case, bonds were the beneficiary of a flight-to-quality move by investors, meaning the yield on the 10-year fell below 3.7%. Can we still blame light summer volume for the exaggerated price moves? No – not after Labor Day.
Dow Jones Industrial
10 yr Treasury (Yield)
If it's not one thing, it's another. Just when the one-time frightening inflation picture began to ease up a tad (on declining commodities prices), a few key reports caused investors to sour on the economy's prospects for future growth. The retail picture remained bleak and back-to-school discounts did nothing to lure consumers back into the malls. Same-store sales in August were softer than expected, with only discounters like Wal-Mart Stores Inc. (WMT) posted promising results. Mall clothiers like Abercrombie & Fitch & Co. (ANF), department stores like J.C. Penney Co. Inc. (JCP), and luxury retailers like Nordstrom Inc. (JWN) each struggled from lackluster activity in August.
Of course, many consumers remained concerned about their jobs, as the unemployment rate soared to 6.1%, the highest level in almost five years. Additionally, over 80,000 non-farm jobs were lost in August, bringing the total for the year to about 550,000 vanished jobs. August represented the eighth consecutive month of a declining labor market. Meanwhile, the housing sector is showing no signs of rebounding, as construction spending fell for the 16th straight month. A total of 9% of borrowers were reported as either delinquent on their mortgages or already in foreclosure.
On a positive note, the services sector surprisingly expanded in August, the first such showing in three months. The U.S. central bank's Beige Book confirmed what most everyone already knew: The U.S. economy is slowing across most regions, but falling commodities may bring some inflation relief. Both the European Central Bank (ECB) and the Bank of England chose to leave their short-term rates unchanged, removing some pressure from the Federal Reserve here in the United States to raise its Federal Funds rate in the near future.
Weekly Economic Calendar
Construction Spending (07/08)
Lowest level in activity in 7 years
ISM – Manu (08/08)
Revealed no real sector expansion or contraction
Factory Orders (7/08)
5th consecutive increase in orders
Fed Beige Book
Slower growth, but with some relief from inflation
Initial Jobless Claims (08/30/08)
Surprising increase in weekly claims
ISM – Services (08/08
Slight sector expansion
Unemployment Rate (08/08)
Highest level since September 2003
Nonfarm Payroll Additions (08/08)
More jobs lost in August than expected
The Week Ahead
Consumer Credit (07/08)
Initial Jobless Claims (08/6/08)
Balance of Trade (07/08)
Retail Sales (08/08)
News and Related Story Links:
- Money Morning Market Analysis:
Oil Slides on Safe Storm Passing, Stronger Dollar.
Oil Falls to Five-Month Low on Dollar Gain, U.S. Jobless Rate.
- Department of Energy's Energy Information Agency:
The Organization of the Petroleum Exporting Countries.
Producer Price Index.
Ospraie fund to close after 27 percent August skid.
Oil falls on soft U.S. fuel demand, shrugs off Gustav.
- Money Morning Presidential Election Series:
Election 2008: A McCain Victory Won't Mean Same Old Republican Story.
- Hedge Fund Research Inc:
Corporate Web Site.
- Money Morning News:
Weak Labor Market and Slowing Retail Sales Put U.S. Stocks in a Tailspin.
About the Author
Before he moved into the investment-research business in 2005, William (Bill) Patalon III spent 22 years as an award-winning financial reporter, columnist, and editor. Today he is the Executive Editor and Senior Research Analyst for Money Morning. With his latest project, Private Briefing, Bill takes you "behind the scenes" of his established investment news website for a closer look at the action. Members get all the expert analysis and exclusive scoops he can't publish... and some of the most valuable picks that turn up in Bill's closed-door sessions with editors and experts.