So when does the selling in the risk asset markets stop. That is the main question in the minds of all traders and investors. Even Friday's widely publicized Facebook IPO was a disappointment closing at the IPO price. Yes most all risk asset markets are overdone by any measure one wants to apply. Gold and precious metals markets are the only risk asset classes that have experienced a short covering rally over the last two sessions... primarily from the perspective that some market participants are starting to view all of the negative macroeconomic data may lead the US Central Bank to move toward another round of quantitative easing. That sentiment has not permeated to the other risk asset markets just yet.
The main underlying reason for the selling is simply a slowing global economy coupled with chaos emerging in Europe surrounding Greece and now even possibly Spain. The euro has never been more threatened and the outcome is still very uncertain. All that one hears are comments coming from the various EU leaders that everyone wants Greece to remain in the euro with no suggestions as to how that is going to be made possible. Even the G8 meeting over the weekend ended with nothing other than that same statement, a lot of photo ops but no solutions to prevent a Greek exit from the euro and what the implications may do to the rest of the euro zone.
Once again Greece is the single biggest risk in the very short term to the fragile global economy. A Greek exit could result in a very chaotic situation as other EU member countries...especially the southern members try to preserve order to their financial situation. Over the last several days the rating agencies downgraded most all of the major Spanish banks sending a signal that Spain may be the next victim of the sovereign debt crisis that the EU has not been able to solve and has only kicked the can down the road for the last three years. As many said eventually the problems are not going to be able to be pushed into the future. We may be approaching that point in the short term.
I see nothing in the short term that suggests to me that all of the imminent headwinds are going to go away anytime soon. I believe the global risk asset markets...including oil are going to remain under pressure for the foreseeable future. Yes there will be some short covering rallies but I would not take that as a signal that the worst is over and all markets are ready for a turnaround. We will have to see some concrete support for a turnaround. I am also starting to believe that the US Fed will enter into some new form of QE as operation twist expires. The only way my view would change would be if the macroeconomic data out of the US improves noticeably compared to the last few months...especially in the area of employment.
I also expect that the Chinese government will get a lot more aggressive in easing. They are very exposed to the European economy which in my view is going nowhere quick with a current GDP with zero growth... or what I would call a recession. I am expecting the next round of easing will be to not only continue to reduce bank reserve requirements but also reduce short term interest rates. China is in a transition year with new leadership set to take over the country in the fall. China will try to make that transition as smooth as possible and that will require a lot more stimulus entering their economy to keep their growth rate around the 7.5% GDP target they set earlier in the year.
I also am starting to believe that the EU will have no choice but to also come up with some form of a stimulus program in the very near future to arrest what could possibly be a very chaotic period. The EU situation is far worse than the Lehman Brother period. I do not think the EU will just sit by and let the situation evolve without intervention. They will come up with a program of some sorts by the time of the EU summit in June. It will likely have an element of stimulus in some form.
So what does all of this mean? It means to me that by the start of the second half of this year the entire global economy will once again be on life support from a variety of stimulus programs from each of the main economies of the world. Whether it will be enough to prevent the global economy from moving back into another recession during a period when the global economy should be in a robust recovery from the last recession is a big question. I do expect most risk asset markets to continue to remain in the overall downtrend with bouts of short covering from time to time. The current pattern will likely play out for the next month or so. Beyond that I think there will be more clarity from an EU program to handle Greece and Spain as well as more stimulus in the US and China. At that point we could start to see a bottoming in oil and other risk asset markets.
Unlike the rest of the risk asset markets oil is very susceptible to any and all geopolitical risk. This coming week Iran and the West will engage in their second meeting. I expect the May 23rd meeting to again end with some progress with another session then scheduled. Iran is being impacted by the EU embargo way more than the west is. In fact the G8 again reiterated that they are ready to release more oil form the Strategic Petroleum Reserves if any shortfalls appear. I think diplomacy with tough sanctions are working especially with the threat of military intervention if all else fails will be enough for the Iranians to agree to some sort of a deal that makes the west and Israel comfortable for the medium term. I do not expect any military action nor a supply interruption from the Middle East in the foreseeable future.
Over the last week the oil complex was lower with the complex losing between 4 to 5% for the week. The June WTI contract decreased about 4.84% or $4.65/bbl. The July Brent contract ended the week with a decrease of 4.56% or $5.12/bbl. The July Brent/WTI was about unchanged for the week but well off of the highs made mid-week. The combination of the market looking toward the start of the Seaway pipeline on Saturday, May 19th (expected to move about 150,000 bpd of oil out of PADD 2 to the US Gulf) and the easing of the tensions in the Middle East may be enough to start to send the spread bulls to the sidelines going forward. Barring any change in the current geopolitics of the Middle East I still expect the spread to gradually continue to narrow over the next 3 to 6 months as the surplus in the US mid-west continues to recede.
On the distillate fuel front the Nymex HO contract decreased by about 4.5% or $0.1336/gal on the week even as distillate fuel inventories decreased much more than expected last week and as US distillate fuel exports were steady on the week. Gasoline prices also decreased on the week after another surprise decline in gasoline stocks. The spot Nymex gasoline price decreased by 3.71% or $0.1113/gal this past week.
Nat Gas futures increased on the week while closing above the technical resistance (now support) $2.73/mmbtu level. The June Nat Gas futures contract gained 9.29% or $0.2333/mmbtu on the week and is now trading with around the key resistance area of $2.73/mmbtu.
Nat Gas has recovered quickly from Thursday's post inventory sell-off and is trading well above the $2.60/mmbtu level above the next resistance area of about $2.733/mmbtu. Whether or not the market goes much higher from current levels will be driven by the market's perception that the surplus of Nat Gas in inventory will continue to narrow as we enter the summer cooling season. Right now the market seems to be forming that view based on the way the market has been able to stay above the first big resistance level of $2.50/mmbtu. In fact the market has traded above this level for the last three trading sessions and after an inventory report that the market initially viewed as biased to the bearish side.
This is the fourth week of the Nat Gas rally but as Robert Frost reminded us in his famous poem it has miles to go before he sleeps. A good metaphor for Nat Gas as it has been in a downtrend for years and this current rally is very young and new being just 4 weeks old. The current rally has been driven by a combination of increases in consumption (mostly from coal to Nat Gas switching) and some production cuts. This has resulted in this year's injection season underperforming versus last year and the five year average and thus the surplus of Nat Gas narrowing over the last several months.
On the financial front equity markets around the world ended were pummeled last week as sellers dominated all of the global equity markets last week. The financial markets were mostly impacted by a series of macroeconomic data in several locations around the world that are still suggestive that the global economy is in a slow growth pattern at best while the ongoing sovereign debt issues in Europe have once again resurfaced but this time all eyes are on Greece. Global equity values decreased as shown in the EMI Global Equity Index table below to the lowest level since the middle of January.
The EMI Index decreased by 6.4% on the week and is now in negative territory for the year by 1.6%. Over the last week the Index decreased in value in all bourses with five bourses now in negative territory for the year with the overall Index now at the lowest level since the middle of December of 2011. The euro lost ground on the week while the US dollar and Yen increased strongly. Last week the global equity markets were a bearish price driver for oil and most commodity markets. Last week was a risk off trading week for most risk asset markets.
I am keeping my view at cautiously bearish after oil broke down on all fronts over the last few weeks but with the possibility for a short covering rally occurring at anytime is increasing. Oil is still solidly below the trading range it was in just a few weeks ago and well below several key support areas. WTI is still solidly trading in double digits with Brent slowly heading in that direction.
I am keeping my view at neutral and keeping my bias also at bullish with an eye toward the upside. The surplus is still building in inventory versus both last year and the five year average and could lead to a premature filling of storage during the current injection season. However, I now believe that we may see other producers starting to signal a cut in production.
Currently markets are mixed as trading is just getting underway.
Dominick A. Chirichella
Follow my intraday comments on Twitter @dacenergy.