Presidential Leadership 101

For the first non-terror related time in his 6 years, President Bush has decided to take a leadership role in containing the rise in energy prices. Accompanying his rhetoric on “America’s addiction to oil” was actual action that was immediately reflected in prices as the press conference broke.

The more important steps:

-an examination of energy prices/supply before adding to the Strategic Petroleum Reserve (SPR)

-a temporary halt in filling the SPR (as a result of the above)

-a temporary EPA waiver for the creation and transportation of certain “clean” fuels and additives to help supply get to the market quicker


While clearly the above will have no impact on many of the geopolitical issues that have created a “fear premium” in oil, it will nonetheless ease prices for the time being and shake out some of the speculative money that has been pouring in the sector. I would clearly look for weaker gasoline, NYMEX crude and a narrowing of the crack spread in the short term.



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The AMEX Oil and Gas Index reverses (intraday) after hitting a new all time high yesterday. Despite a strong up channel, technicals are similar to the January peak and starting to turn down.

Point Break

One way or another, something has to give. Either the energy complex (including commodities in general) need to pullback or the broader market (excluding the ~12% that oil represents) need to retrace. Maybe even both. Who knows at this point?

Following the hurricane drubbing the Southeastern U.S. received last year the economy stumbled slightly, mainly as a result of $3+ gasoline prices nationwide. This was largely the result of diminished refinery output, the virtual shutdown of the gulf ports and millions of barrels of oil being shut in.

The situation this time is different. Most of the risks are geopolitical (Iran, Venezuela and Nigeria) and the price rise is appears to stem from the demand side of the equation in addition to the potential of supply disruptions derived from perceived hostilities with the above countries. Some analysts have approximated roughly $10-$15 of the crude price is fear related.

Another issue is the switchover from MTBE to ethanol as the single oxygenate in U.S. Gasoline, mainly for environmental reasons. The season switch from winter to summer stocks has always been an issue for energy companies, but the new law has only exacerbated the complications and also caused a shortfall in ethanol.

One thing is for sure however, the recent run up in NYMEX crude has more to do with speculators than hedgers. A close examination of the open interest in many of the future contracts exposes the trader mentality that has crept into the commodities markets in general, as companies which rely on oil for their core businesses have seen their trading volumes diminish in comparison with the speculators.

Which leads to the next market related issue—margin requirements. The amount of equity for a typical commodities contract is a fraction of what is need to hold a stock, which often leads to wild swings and excessive volatility during trend changes.

Finally, high prices ultimately lead to demand destruction. Nobody really knows what point that will be or how long it will take to get there, but rest assured—the general population cannot afford to spend this much on gasoline for a prolonged period of time.



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Commodities continue their Bull-Run as Gold, Silver and Oil lead the pack last week, each hitting multiyear highs (oil an all time nominal high).

Ten-Year on a Tear

All eyes are back on the bond market after the very strong employment report that came out Friday morning. Speculators are once again taking action on higher interest rates over the course of the year as this game looks sure to go to “extra innings (quoting a Fed governor from late last year).”

The Ten Year Treasury Note is an excellent proxy for the interest rate trade and usually a reliable predictor of when (and where) the cycle will end:



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Trade Surplus to Spark Debate

China reported a trade surplus of about $11 billion with the United States for March, doubling from this time last year. The Chinese Government’s PR team has already gone on the offensive by highlighting accomplishments in stopping Intellectual Property piracy; along with several commercial initiatives to bolster relations with the United States. They announced a repeal of the current ban on U.S. beef, as well as a $4.7 billion order from Boeing.

Unfortunately, I don’t think this will be enough to placate the opportunists in Congress, mainly Senators Schumer (D-NY) and Graham (R-SC). They will most likely milk this figure for all it is worth and press for sanctions until the Yuan floats freely.

Seeing that the Chinese are a major trading partner for the U.S. (as in they buy A LOT of our goods and services) this is not good. Most leading economists and monetary experts feel that China’s banking system cannot withstand the shock of such a major currency adjustment. Being that their infrastructure is far from transparent, one can only guess what catastrophe may follow such a move.

While the Chinese are far behind the agenda laid out to guarantee their entry to the WTO and previous “Most-Favored-Nation” status, punishing them would in effect be punishing our own interests.

Former Fed Chair Alan Greenspan was single-handedly responsible for keeping our protectionist lawmakers in check, with the vacuum created by his departure we may be in for a rough patch and the thematically grim notion of nationalism may rear its ugly head once again. Hopefully Fed Chair Bernanke can draw on his extensive academic background on trade to push for the right policy.

China needs to make another revaluation, preferably larger than the first but within the same scope. This will keep the Senate happy while providing a boost for our economy as well as U.S.-China relations. Because of their permanent seat on the U.N. Security Council and inherent veto power—it would be a boon for both parties across the board.



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Commodities at Crucial Point

The Morgan Stanley Commodities Index (CRX) closed .73 above its all time high yesterday; with energy, metals and agriculture (mainly corn-ethanol) leading the move.

By the close today, traders should be fairly clear on whether this will result in a double top or break out to new multi year highs. Natural Gas inventories will be released at 10:30am EST and will most likely generate the same volatility that the crude products did yesterday (crude stocks rose more than analysts expected once again, with finished products—gasoline and distillate levels— falling yet again).

Speculation on this year’s hurricane/gulf storm activity did not ease prices either, despite predictions for a less tumultuous season.

At this point, the only fundamental factor that may lead to a price decline seems to be the very difficult year over year comparisons the producers will face. We are nearing the period when oil was above $70/barrel, which should make for some tough comps.



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Watch for a possible double top or follow through to new all time highs (cup and handle most likely scenario)

The New Third Rail

Despite all the vehement opposition to the Iraq War, the “public outrage” never even came remotely close to what erupted over the immigration debate this past weekend. Reminiscent of the Vietnam War, people took to the streets (mainly immigrants and pro-amnesty demonstrators) and brought many parts of the Southwestern United States (and California) to a standstill.

This is significant for two reasons:

1. Immigration, specifically illegal immigration, has distinguished itself as the most dominant domestic issue facing Washington this election cycle. In fact, most demographers speculate that Hispanics will emerge as the largest single class of Americans within the next half century.
2. Bearing the above in mind, this development has far reaching economic ramifications—from social services (health care, housing, welfare, etc.) to tax revenue.

At present, scurrilous labor laws combined with high levels of illegal immigration have made California “ground-zero” for fiscal hysteria in the United States. It is literally impossible to fire someone for any reason in the fine state of CA—and even if you succeed in removing them from the payroll, good luck escaping the lifetime’s worth of health insurance, pension obligations and whatever else Sacramento can muster to disincentive small business owners from taking risk.

The simple answer for the private sector is to hire illegal immigrants. It is a far more equitable solution for their labor requirements than taking on employees for “life.”

While businesses may save money (and I don’t begrudge them whatsoever, they have no other choice) the problem effectively finds itself in the lap of the state, whom refuses to enforce current immigration and labor laws. Now, not only is California losing out on state payroll taxes—leaving less revenue to pay for the social services the illegal immigrants require—and putting an unreasonable burden on the taxpayers, as public funded programs in California are a disaster.

The current system is also not safe for the illegal immigrants (and I don’t begrudge them either), of which most come to this country with the best intentions—a better life for their families, steady work and an opportunity. Because of their status, many are taken advantage of and face extortion and the threat of deportation on a daily basis, in addition to not receiving adequate medical care and education that every American is eligible for.

While things clearly cannot continue as they are, I cannot envisage much being done in the short term, barring a watered-down bill that is marked up in committee until the only thing left is earmarks for swimming pools in Iowa. At any rate, Social Security reform is safe for now as Immigration reform will replace it as American politics’ newest third rail.