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The big news in the markets came from the Commerce Department when they announced the second quarter trade deficit unexpectedly shrank in March to $55 billion. Median forecasts called for a deficit of $61.9 billion with the lowest estimate at $58 billion. The number clearly came in much lower than expected. Bloomberg News describes the impact on the markets as follows: “Stock index futures gained, Treasury notes fell and the dollar rose as the report suggested a stronger economy.” The report did indeed suggest a stronger economy, especially on the heels of a much better than expected employment report last Friday. On face value, stocks should be headed higher today with less demand for bonds moving bond prices lower and yields higher, but just the opposite is happening. WHY??? Recent economic reports have more jobs being created in America than was expected and in March our exports unexpectedly surged higher by 2.5% indicating economic strength. Normally when the economy is strengthening, bond prices move lower. Today’s great news on the trade deficit sent the dollar higher against all major currencies, but bond prices reversed their initial declines from the announcement and have remained in positive territory for the balance of the session. The big spin in the financial media is claiming that today’s action with stocks down and Treasuries higher is because of “increased risk aversion.” All the recent good economic news and the market is still getting arm-wrestled into buying U.S. Treasuries. The “RISK AVERSION” spin is being used to sell Treasury debt as a flight to safety. This afternoon the Treasury is scheduled to auction $15 billion of five-year notes following yesterday’s successful sale of $22 billion of three-year notes. If Treasury prices had continued their early morning declines, it would have been more difficult to draw solid demand for today’s auction. Instead, it was much more expedient (expedient: “serving to promote one’s interest”) to put more focus on some potentially big derivative problems with hedge funds. There is growing talk of credit default swaps being a problem for the hedge fund GLG Partners, but the company does not comment on individual trading positions. Additionally, there has been growing speculation that hedge funds were caught on the wrong side of the trade with the recent volatility in General Motors and Ford in their stocks' prices and corporate bonds. The hedge fund trade was selling GM shares and buying GM bonds. The share sellers were burned when Kirk Kerkorian made a bid to purchase shares above the market price. The very next day the same hedge funds were burned for buying GM debt when Standard and Poors reduced the quality of GM debt to junk status. Well, Well, Well. I just turned back to the markets and stocks have turned into positive territory. The U.S. markets are looking like Utopia. Stocks are now higher, the dollar is notably higher and Treasuries are catching a bid across the board. Treasuries continue to defy the market, even as three Fed governors (Poole, Hoenig, and Fisher) were all out yesterday talking of a stronger U.S. economy and that slowing growth was temporary and interest rates would continue to rise. That was yesterday. Today interest rates are moving lower with the manufactured demand for the U.S. Treasury auction. I just turned CNBC on for the fourth time today and once again the topic is “Hedge Funds and the Market.” If they create enough insecurity and fear for the markets, Treasuries should continue to sell. Once the Treasury auctions are out of the way, we will probably find out that all of these worries over a major hedge fund derivatives crisis are all overdone. It worked well to create a demand for Treasuries in light of strengthening economic data. Also on the interest rate front, the Mortgage Bankers Association reported its applications index rose 9.4%, with the purchase index higher by 9.1% and the refinance index up by 9.8%. One-year ARMS moved six basis points higher to 4.20% and the 30-year fixed rate rose three basis points to 5.77%. The Feds keep talking a hawkish stance toward inflation with higher interest rates, but it sure isn’t happening yet with 30-year fixed rates still below 6%. Rampant speculation in housing continues… News on Energy Crude prices tumbled $1.52 to $50.55 a barrel today when the Energy Department said crude inventories grew by 2.7 million barrels and gasoline inventories grew by 200,000 barrels. At the same time the Energy Department announced higher inventories, the International Energy Agency reduced global demand for the fourth quarter on speculation China’s demand will decline. The IEA reduced its forecast for 2005 demand growth in China, the world’s second largest oil consumer, to 7.4% from the 7.9% increase expected back in March. Talk about expedient, this takes pressure off inflation and the dollar, not to mention it’s easier to sell Treasuries with a falling oil price. Now let’s flip over to some other sources of information in the oil patch. First of all, the Energy Department claims crude grew by 2.7 million barrels, but the American Petroleum Institute reported crude inventories actually DECLINED by 6.1 million barrels. Who should we believe with such a large discrepancy in the numbers? Similarly, the government claims a build of 200,000 barrels of gasoline, but the API reported a build of only 84,000 barrels. The market expected a gasoline build of 800,000 barrels, so both inventory reports came in well below estimates, but the price of gasoline declined by more than 2% today to close at $1.479 a gallon. In my opinion, oil came down today because the dollar strengthened, not because of the bearish numbers from the Energy Department. Lower oil makes the dollar look better, and the dollar needs all the help it can get…even if it is pure propaganda. I believe the announcement from the IEA about China’s demand falling in the fourth quarter is also a piece of propaganda intended to help bring the current price of oil lower. I found a recent article based on comments from an industry insider that offers some insight as to the motives of the IEA. Here is an excerpt from what I read: “Our executive was very familiar with the Simmons assessment of the natural gas situation. His company’s own internal projections aligned closely with the pessimistic scenarios of natural gas supplies painted by Simmons and others. He was less than impressed with the commonly referred to assessment of future North American supplies depicted by the EIA however. That assessment—in his opinion—relied on ridiculously optimistic assumptions of future production that were unlikely to ever materialize. The agency’s perennially optimistic assessments largely originated out of political considerations. According to the executive, they used to make more pessimistic assumptions until Congress cut their funding in the mid 1990’s. Since then, the EIA has sung a more upbeat tune about energy reserves. This similar level of optimism permeates the USGS and influences some of the consultants (that accept federal funds) as well.” The government is overstating oil inventory relative to the API numbers and the IEA clearly has ulterior motives to paint an optimistic energy picture by reducing forecast demand. I stumbled over the article when I was doing research to better understand the fundamentals of the North American natural gas market in conjunction with the global LNG trade (liquefied natural gas). (Here’s a great website if you want to learn more about energy: www.energybulletin.net) I’m quite bullish on natural gas based on the fundamentals as the following paragraph from the same article suggests: “When asked about the various natural gas supply and demand charts circulating out there from various sources (such as the EIA, Matthew Simmons, CERA, California Energy Commission, Sempra, and ASPO) that paint differing pictures of depletion in North America, the executive confirmed that the pessimistic projections of future gas supply were in fact the most probable to occur. In his professional opinion (which was backed by years of hands-on experience in the energy sector) the natural gas situation is on the verge of significant shortfalls. Depletion is taking an increasing toll on producers by forcing them to drill more frequently and in more challenging locations. New wells are producing less and depleting faster than ever before. Drilling activities are at all time highs with exploration firms unable to significantly increase capacity due to acute equipment and labor shortages. (This fact has been corroborated by various business journals observing the run-up in drilling rates charged to the various energy firms). Meanwhile depletion rates in mature regions are reaching distressing proportions. South Texas depletion rates have begun to reach levels of 14 to 15 percent. The overall Lower 48 depletion rate is now approaching 2 percent per year, which in itself is problematic as natural gas demand has been increasing by 2 percent per year.”
When you cut through all the noise, it doesn’t matter what the dollar is doing relative to other currencies if we can’t find enough natural gas in N. America to supply our needs. There isn’t enough capacity to import our needs, so it must be found here. If the resources are not discovered fast enough to supply the growing demand, higher prices will be necessary to allocate the available supply. This is one of my favorite investments for the next few months. When summer demand for electricity increases, it will put a big strain on nat-gas inventories since the overflow capacity for electricity generation comes from natural gas fired plants…California has some especially big problems in this area. Today’s price action in the energy complex spoke well for natural gas. Oil was down 3.1% today, gasoline was down 2.1%, heating oil fell 3.0%, but natural gas only fell by 0.4%. Crude oil helped to pull nat-gas down today, but I used it as a buying opportunity. Since I have focused on supply/demand fundamentals to determine my investment positions, I must point out that there appears to be some tightness in the physical silver market. First, here are some very recent comments from Expert Silver Analyst, Ted Butler regarding the big picture on supply/demand fundamentals: “Silver is special among all commodities. It is the only commodity to be in a structural consumption deficit. This deficit stretches back 60 years. This structural deficit has gone on for so long, that we have reached the point where a surplus production year or two, not that one is apparent, won’t really matter. World silver inventories have been so severely and irreparably depleted, that they will never be realistically replenished, regardless of price.” “Let me repeat that – no matter how high the price may go in the future, the world will never restore silver inventories by more than a percent or two, of what existed 60 years ago. Sixty years ago, the world had 10 billion ounces more in above ground silver than it does today. It is hard for me to conceive, no matter what the price, or the number of years required, how the world could add even one or two hundred million ounces to above ground inventories. Not with the growing new industrial uses and hundreds of millions and billions of new prospective world consumers.” Mr. Butler also made some comments on the tightness of the deliveries for the May contract as follows: “I see some new and exciting signs that indicate that the inevitable delivery problem on the COMEX may be upon us shortly. If you remember, when we concluded the recently expired March contract, the market recorded a premium in the March contract of 3 cents to the May silver contract. This was almost unprecedented and reflected a clear tightness in the physical market. It appeared to be users clamoring for the spot March and subsequent warehouse movements confirmed this appearance.” “Now, the May contract is demonstrating its own tightness. Only ten days into the delivery month, we are actually more advanced compared to the expired super-tight March contract at corresponding times. The spreads are tighter in the May contract, there is more remaining for delivery and there is more new user buying of the May, than took place in the March contract at this time of the delivery month. Additionally, the move to tightness has suddenly impacted all the trading months in COMEX silver, something that never happened in the March.” In addition to what Mr. Butler has to say about the tightness in the silver market, the silver lease rates are confirming the lack of above ground silver inventory. In the last week, one-year silver lease rates more than doubled from 1% to 2.15%. Some precious metals analysts are suggesting the spike in lease rates is due to dealers being forced to borrow the silver they sold short (sold it without actually having it) and now they have to come up with physical silver to meet delivery demands. Lease rates have begun to settle down, but this development screams of tight supply! I’m tuning out the day to day market chatter, especially during a week when the primary objective is to sell U.S. Treasury debt. I really like the fundamentals for silver and natural gas. They can play all the paper games our financial managers can conjure up, but when push comes to shove (real users, competing to take delivery of real product) they won’t be able to make silver or natural gas out of paper fiat…inevitably, economics dictates that PRICE will allocate the available supplies to the ever increasing global demands until more production can be brought online. I’m sticking with the fundamentals!!! Have a Great Evening! Mike Hartman
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