WTI Was Up 5.5% This Week

In this article, I will review some of the trends I have been discussing and the news surrounding them. Then I will discuss the latest movements in oil. After the crash to the upper $40s, the commodity has moved back above the $50 level this week. This is great news for the American shale firms. This challenges my prediction for energy earnings to miss 2017 expectations. My initial projection was for the energy and retail sectors to miss 2017 earnings expectations which is why I saw S&P 500 earnings growth coming in between 4% and 6% which is below the 9.8% growth expected. Even if oil stays in the low $50s, I still think S&P 500 earnings will miss estimates because of the latest metrics which show bank lending is constricting. This will hurt the financials earnings more than the Fed rate hikes will help them.

A key long-term theme I have been discussing for months is the bubble in financial assets. The chart below shows the long-term relationship between real assets and financial assets. Some will say the economy has progressed past valuing real assets, but they’re only saying that because of recency bias. Recency bias affects even the best investors because it’s tough to determine whether a paradigm shift has occurred or if a mean regression is about to take place. There needs to be overwhelming evidence for me to ignore historical results and believe a new paradigm is here. That’s why I reject the notion that historically high profit margins are here to stay.

The reason financial assets have been doing so well in the past decade is because inflation has been low and there has been a relatively high amount of peace in the world. When there’s relatively high peace in the Middle East, more oil is produced, thus lowering inflation.

One question some investors who recognize this bubble may have is whether bitcoin is a financial asset or a real asset. According to governments, bitcoin is a commodity which would make it a real asset. Although I view bitcoin as more than a commodity because it has a dynamic value added proposition, I agree that it’s a real asset since there’s a limit to the amount that can be created. For an analogous situation, bitcoin is like when silver was being realized to have properties which would make it useful in electronics. Bitcoin will have much more of an impact on society than silver.

Before I get into the latest movements in oil, let’s look at the new updates to the Feds’ GDP forecasts. Both the NY and Atlanta Fed’s forecasts fell one tenth of one percent. The Atlanta Fed sees GDP growth coming in at 0.9% and the NY Fed sees GDP growth being 2.87%. I don’t have much insight into the historical results of when the two forecasts have differed so greatly because I haven’t been following the NY Fed’s forecast for long. Both forecasts fell because the U.S. Bureau of Economic Analysis’ forecast for first-quarter real consumer spending growth fell from 1.4% to 0.8%.

Oil prices may have risen in the past few sessions, but as of Thursday’s close, it still was the worst performing asset in Q1 among the assets listed below. (WTI ended the quarter down 6%.) Oil’s weak performance led the CRB commodities index to fall 3.5% year to date. Interestingly, the banking index is up only 1.4% year to date as the post-election rally was unsustainable. I expect it to underperform for the rest of the year as delinquencies rise.

Oil prices would need to rally much more to make the increasing base effect be more than a temporary blip. As you can see in the chart below, the base effect increase will be negligent in the next few months if the price stays where they’re at now. The 80% increase in oil got the PCE deflator to 2.12%. I am interested to see if the Fed puts the brakes on rate hikes after the second one this year when it sees inflation falling because of oil. Looking at rising oil prices as a driver of inflation means financials should rally when oil rallies because it increases the chances of rate hikes.

Most of what I have said thus far has been a recap of the intermediate term move in oil. Lately oil prices have been rallying. One of the reasons for this is because gasoline stocks, as reported by the EIA, have declined back to their five-year range. As you can see in the chart below, the seasonal nature of gasoline usage makes stocks decline in the spring and summer. The decline this year has been a little bit faster than usual. This decline is likely caused by U.S. demand. This is good news for the economy. Production has been increasing at shale firms as they have lowered their breakeven price. It’s great news to see the production being soaked up by drivers. The hope for oil bulls is the summer driving season is strong.

Even though I mentioned Middle Eastern oil production has been relatively high as it has been boosted by Iraq’s production growth in the intermediate term, the latest increase in prices has been spurred by a decline in Libyan production. Libya’s largest oil field, Sharara, was shut in for an unknown reason. This has caused Libya’s daily production to fall to 560,000 barrels per day from 700,000 barrels per day. It’s tough to comment on what this means for the long-term price of oil because there was no reason given for the shut in.

The final reason why WTI rose 5.5% and Brent rose 4.0% this week is because of OPEC’s discussion of possibly lengthening the production cut. The next meeting will be in Vienna on May 25th. Russia is also on board with production cuts to reduce the glut. Russia reduced an average of 202,000 barrels of production per day in March. It plans to raise the cuts to 300,000 per day by the end of April. If these cuts increase oil prices further, it will be music to the shale producers’ ears.

Spread the love

Comments are closed.