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Today's Market WrapUp 10.09.2007 Mon Tue Wed Thu Fri Barbera Archive Energy Update - Part
One This year has been another rewarding one for Energy investors as prices have firmed throughout the year after starting in a headlong plunge. Investing in Energy is never for the faint of heart as the incessant commodity related volatility guarantees many a lively morning. Yet for the last few years, the trend for Energy prices has been solidly higher, and with the US Dollar weakening over the last few months, this has only served as a prop for energy prices. In today’s commentary, we are updating the technical view of Energy prices, with a focus on Crude Oil this week and Natural Gas next week. Earlier this year, Crude Oil began January 2007 with what looked like a serious price collapse. Falling nearly day after day, Crude plunged toward $50 per barrel during the first three weeks of the year. At the time, we viewed the decline in the Oil price as completing a major intermediate degree correction from the highs in July-August 2006. At the time, we wrote an article which forecast a move back up across the entire range for Crude Oil and suggested looking at the then ‘down and out’ Oil Drilling Stocks, which have turned out to be among this year's best performers.
Since the major low in Crude Oil back in January, prices have not only moved back up across the range, but have most recently moved to new highs above $80 per barrel. From an Elliott point of view, the advance has traced out a clear-cut five wave advance, which could recently have reached an important price juncture. At these levels, the risk-reward profile on Crude Oil is currently highly questionable and thus investors should ‘go slow’ and step up monitoring of energy related positions. Mind you, we are not turning bearish on Crude, but simply believe that the market has come to a point where the most likely outcome is probably a trading range for a period of two to three months. Under different circumstances, with the threat of a US recession continuing to grow in our view, and over-extended market charts dominating the portrait of Asian markets, especially China, -- we could be turning actively bearish on Crude. Another element to consider would also be the proximity to former highs, which often act as price resistance. Yet, today’s circumstance is radically altered by the recent turn by the Fed toward a policy of monetary easing. In doing so, the Fed is kicking out the support from underneath the US Dollar in a move for which they will almost certainly eventually pay for dearly. Opening the door to a currency crisis is no solution to a bad debt problem, except it spreads the pain over an even wider number of individuals, in this case, everyone holding dollars.
Above: the Updated Elliott View on Crude which shows a five wave advancing structure that may have reached a more important peak over the last few days. As a result, the trend toward a lower Dollar will tend to under-pin the Dollar price of Crude Oil, implying that the downside risk may not be that substantial. Under ordinary circumstances, we could see Crude Oil setting up residence in a trading between $74 and $84 over some number of months, which for many US producers is a boon to bottom line profits. Yet, from the stand point of a commodity trader, a market moving sideways offers goods “hit and run’ opportunities, but not the ‘set and forget’ pleasantries of a strongly trending market. However, recent times have been anything but ordinary. As can be seen by the huge write downs at JP Morgan, Citicorp, Bank America, and UBS, the recent credit crisis did a tremendous amount of damage in a short period of time. The Bernanke solution seems to be to throw money at the problem, and allow the Dollar to sink against other global currencies. Among the OPEC Countries, the weak dollar is causing pain on several levels. To begin with, all of these countries have to varying degree’s, in recent years, enjoyed major construction booms, particularly in Qatar. In virtually all of the Gulf States, domestic inflation has been heating up and is running at 5% to 6% annualized. Curbing domestic inflation is rapidly becoming a major issue, which has now been exacerbated by the Bernanke Rate cuts. For the Gulf State OPEC countries, an easy Fed means they are importing via the Dollar peg, an easy monetary policy at precisely the time when they need a tight monetary policy. As a result, pressure is now building for the Gulf State Oil producers to move away from the US Dollar Peg, and allow their currencies to either revalue or break the peg. These are heady days indeed, with the US Dollar in imminent danger of being dethroned from the world's status of Reserve Currency. For years, the US has enjoyed unprecedented seniority and the luxury of being able to pay its debts in the currency it is able to print. Now, the threat exists that Gulf State countries will break from the Dollar Peg, and move to price Oil in a basket of foreign currencies, possibly including the Euro and the Yen. Already this year, Kuwait, Iran and just recently Qatar have moved away from a Dollar centric universe. Of especially major note is the Saudi Arabian Riyal, which since September 18th, the day the US cut the Fed Funds Rate by 50 bps, has moved away from, and remained off of its prior Peg at 3.75. Are these normal times? Hardly!
As a result of the Dollar weakness, especially against the currencies of the Gulf State Oil producing countries, we are inclined to step back from our call earlier this year (see below) that suggested a potentially more substantial high for Oil in this time frame. Instead, we believe Oil prices could plateau for some time, and could even rise further if this winter turns out to be especially cold. On the bearish side, we would also note that recent data from the Commitment of Traders Report (COT) shows Commercials heavily short Crude Oil, with Large Speculators heavily long. In the chart that follows, we show a NET of Commercials less Large Speculators with that oscillator now deeply negative. In the past, this has not been a great sign for higher Oil prices and in our view, is another element of the current Oil picture which makes it difficult to get overly bullish on Crude, with Crude already trading at lofty levels.
Above: Under more ‘normal’ circumstances, a looming slow-down/recession could be setting up a more important high in Crude Oil. Back in January we put forth the idea that prices could run back up across the range, make a peak and then roll over into a second decline, which would fill out a large A-B-C structure, still within the context of a longer term uptrend. However, in light of the recent US Dollar breakdown, and the threat that OPEC currencies will be realigned in the days just ahead, the odds of Oil undergoing a serious decline are not that substantial. Instead, we could see prices level off, and then move higher, especially if pressure on Arabian currencies continues to mount.
Above: Crude Oil and the Commitment of Traders Oscillator, Commercials less Large Speculators, showing that Large Speculators are heavily net long, and going up against Commercials who are heavily net short. Usually, the commercials carry the day, and thus low readings on this oscillator are a caution sign. For those who are not interested in trading Crude Oil futures, but who may be wondering what, if anything, can be achieved via Crude Oil moving sideways in a wide range, we have but one answer: Energy Trusts. Before going on, we note that these vehicles ran into some heavy volatility last year when Canadian tax law changed, and appeared to adversely affect the dividend payments from their trusts. As it turns out, the real change in the tax treatment will not kick into gear for several years, and with luck, may be modified in the meantime. So, perhaps the dramatic sell off in these Energy Trust names was overdone by the severe reaction seen in October 2006. In any case, we list a number of these Trusts (and other high dividend yields) for you, in no particular order in the table below. Along with the stock symbol, the recent dividend yield is quoted as reported by TC 2000, a Worden Brothers service. Readers should be advised that a fair amount of homework is needed when evaluating Energy Trusts, as some of the Trusts are paying out more than they should in dividends, and are not replacing their reserves at a rapid enough rate. In these cases, the Trusts are self-liquidating entities and the share price becomes vulnerable to an extended decline. Yet for those willing to do some homework (please no e-mail’s), these Trusts and Royalty companies which are replacing, or growing their reserves, can thrive in an environment of stable Oil prices, supported by a lower dollar. Arguably, with the US Stock Market operating in a very high-risk climate, for those patient enough to collect dividends, the returns on many of these Trusts may be truly worth the effort. As we see it, with Crude Oil not far from all time highs, this is basically a very healthy environment for many of these stocks, many of which are not that far above their 52 week lows.
Stocks rallied on Tuesday in the wake of a Fed Beige Book report which showed unanimous agreement among Fed governors regarding last month’s sharp cut in interest rates. At the close, the DJIA ended up 120.80 at 14,164.53, with the S&P 500 up 12.57 at 1565.15, and the NASDAQ Composite higher by 16.16 at 2803.53. The 10 Year Government Bond Yield ended at 4.65%, down .01, while nearby Gold ended higher at $743.70, a gain of $5.00 per ounce. That’s all for now, Frank Barbera Copyright © 2007 All rights reserved. CONTACT
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