They Are So Tired.
They're so tired, they haven't slept a wink. They're so to tired, their mind is on the blink. They wonder if they should get up and fix themselves a drink but what they really are wondering where all the bullish momentum has gone. I mean come on it seemed like the oil bulls were on top of the world as the year started on such a bullish note. The bulls had their arguments like cold weather and China but with every passing day those arguments become more tired.
On the other hand the bearish case is wide awake. We have weak demand, ample inventories, rising OPEC and non-OPEC production and questions about the continued growth in China oil demand. Now throw in some proposed new banking regulations that could zap demand and it's the bull's worst nightmare. No wonder they can't get any sleep. The bull market and the bulls are just downright tired.
The Energy Information Agency weekly report did not help out the bullish case. The EIA did report that oil supplies fell modestly (400,000 barrels) and that we had a big drop in distillates (3.3 million barrels) but are we not to expect that when the weather is cold? And we are still above the average range in both categories. At the same time we had a huge build in gasoline supply 3.3 million barrels and a historical low refining run rate of 78.4 % which just seems too scream out weak non-weather related demand.
Of course the oil bulls would tell you that it is not about US oil demand but demand from China. Yet is it possible that the oil demand story is not all it seems or at the very least the oil market got far ahead of the China demand story. I have been raising this issue for some time. Yesterday I warned that despite the fact of an explosive Chinese growth rate of 10.7%, the impact of China raising reserve rates and desperately reigning in credit could cause problems for the oil bulls. I warned that even though it raised market fears, the Chinese government will take even more steps to reign in credit. I said that the market's reaction to the banking news could really be saying something more profound about how the market feels about the Chinese economy and even more, the health of the Chinese banking system as a whole.
Today the Wall Street Journal's Liam Denning raised those same issues as well as others that I have talked about. Liam points out that, last year, the Nymex crude oil price rose surged 78% despite global oil consumption falling for the second year in a row. China's continuing thirst for oil helped enormously as developed markets fell into recession. Ex-China, global consumption fell by almost 3 million barrels per day between 2007 and 2009. With China, it fell just 1.6 million barrels per day, according to the International Energy Agency.
But says Denning, As is often the case, however, there's more to China's numbers than meets the eye. He says that the country's actual demand for oil, calculated as output from refineries plus net imports of refined products, jumped by 14% in 2009 quoting estimates from GaveKal Research. Gross domestic product growth for all of 2009 was 8.7%. Based on multi-year moving averages, China's ratio of oil demand growth to GDP growth should have been between 0.37 and 0.75 in 2009. That implies oil demand growth of just 3.2% to 6.5% last year. These numbers lend weight to a widely-held view that China has been stockpiling oil. Denning says that, Another hint: Recent large exports of certain refined products from China suggest storage constraints.
More important will be growing financial constraints. Beijing has kicked off 2010 by imposing restraints on a domestic lending boom that has fuelled huge gains in speculative assets like real estate. Lombard Street Research says annualized growth in Chinese broad money and bank loans has been running at just under 20%, despite economic growth having largely recovered. That's a recipe for inflation and asset bubbles. Liam says that, Less lending means less money to finance further oil stockpiling, weighing on prices. The more extreme risk would be for actual liquidation of existing stocks to kick in, which would savage cash prices. Chinese monetary tightening could limit gains for investors in passive vehicles tracking oil indices.
A headwind already exists because of a sustained switch in the futures market to an upward sloping curve, known as contango. Funds invested in oil futures typically roll their positions by selling near-term contracts close to expiry and buying longer-dated ones. When the matter are more expensive, the negative return on that roll erodes gains made from increases in the spot price of oil. For example, in 2009, the Standard & Poor's GSCI Petroleum index made a notional spot price gain of 71%. But the total return, after accounting for the negative roll effect, was 19%. High oil inventories and weak end demand mean the contango structure will likely persist. Can passive investors really expect big gains in spot prices this year if China keeps tightening?
I say that the answer is no. That is why as I have been saying that oil is near a major top and is most likely headed back down towards $40 a barrel.
Will the CFTC kill the retail Forex business and outsource trading, jobs and liquidity offshore? It is possible and PFGBest is sounding a warning signal. This week PFGBest said that it was in favor of the CFTC's proposed rules regarding Retail Forex Transactions but hopes that leverage will remain the same to avoid unintended negative consequences of job losses to foreign competitors. PFGBest does offer strong support of the CFTC as it has provided clear guidance and a comprehensive scheme of regulatory requirements to govern retail foreign exchange trading in the United States. Once again the CFTC has provided clear regulatory guidance that in the past has made it the premier regulator of the derivatives industry. In particular, the CFTC has fixed the regulatory capital requirement to $20 million plus 5% of liabilities that exceed $10 million, reinforcing its serious intent to protect customer interests. PFGBEST will provide comments to the proposed rules to assist in making forex regulations similar to other derivative rules that have provided market integrity and customer protection in the futures industry. One key components of the proposed rules that PFGBEST will comment about concerns a likely unintended negative consequence. A leverage structure change in retail forex margining from 100 to 1 to 10 to 1 will force a great majority of forex business to be done offshore and thousands of U.S. jobs would be lost in the derivatives industry to European and other foreign competitors. Worse, U.S. forex customers would not be protected by the CFTC. PFGBEST feels that U.S. forex customers deserve the best protection available. PFGBest says that it was clearly not the intent of the Congress to destroy the U.S. retail forex industry when the CFTC was given the authority to create rules for retail foreign exchange. Congress made it clear that the industry was to be policed, not abolished. The 100 to 1 leverage structure was changed from 400 to 1 earlier this year when the NFA submitted rules which the CFTC approved. This governance created clear guidance and market protection while keeping the United States competitive with the offshore competitors even though it was a higher requirement. Below is the link to the comment letters to the new proposed CFTC rules regarding retail forex. The comments are mostly from retail FX traders that are angry and frustrated with the CFTC's new proposed rule to change the leverage from 100 to 1 to 10 to 1. Comment letters are one of the best ways to help our regulators and Congress understand the complexity and consequences to the rules that they are proposing.
For the most part it appears that the mass opinion is very similar to that of PFGBEST. PFGBEST is in full support of the CFTC requiring registration for retail forex dealers and making the rules similar to futures. The only issue with the new rules is that 10 to 1 leverage is too restrictive and 100 to 1 leverage makes sense. PFGBEST agrees with the mass opinions in this aspect.
PFGBEST is concerned that the change in leverage will effectively force all business to be moved outside the U.S. where there is not as much customer protection. If U.S. business goes offshore, there will be loss of jobs in the brokerage industry here. This is not just a forex brokerage business issue. Most futures brokerage firms are surviving now only because they are supplemented by income from the foreign exchange industry. Many trading platform vendors, advertisers, IT developers, trade expo companies and other related industries will be affected by the loss of U.S. derivative brokerage business. This is an important milestone for the derivatives industry. If this leverage change is allowed then there will be even more massive consolidation and downsizing across the industry.

Phil Flynn
Senior Market Analyst