Commodity Market Cross Currents

Cross currents in the commodity markets are currently swirling worse than Hell Gate at the height of ebb tide. Hell Gate, for those who don’t know, is that dicey stretch of water between the Bronx and Queens that leads from Long Island Sound to the East River. If you imagine Connecticut and Long Island as the sides to the wide part of a funnel and Hell Gate as the narrow bit, you can get an idea of the chaos those hydrodynamics can cause, especially when you throw in the opening across the top of Manhattan that leads to the Hudson. Talk about “swirl”!

The demand question is a constant seesaw between the weakness seen in the U.S. and Western Europe vs. that in the BRIC countries and Asia sans Japan. Recent studies by the EPA, the National Highway Traffic and Safety Administration as well as notables from UC Irvine and the OECD examined what is known as the “rebound effect” which describes the degree to which drivers that trade in low MPG vehicles for a higher ones will increase miles driven because of the better mileage. The median finding was around 5%, which can also be interpreted as a net decrease in demand of 95% of the gas saved from more efficient vehicles.

Besides the decrease in demand just mentioned there is also an insulating factor to the consumer from the current run up in energy prices so that even a run to last years levels would not take the same bite out of the average American’s wallet.

The decline in energy usage across “Westernized” economies is countered by those on their way to becoming so. China, the “C” in BRIC, appears to be the key to much of this as Lars Steffensen, MD at Ebullio Capital Management, a London based commodity fund recently stated: “A lot of people have looked at China as a bellwether for when the world is going to recover”. “If you just focus on U.S. demand as many tend to do, then it is hard to justify the nearly doubling of oil prices in the past months”, Paul Ting, of Paul Ting Energy Vision said.

It is not just “erl” we are taking about here either. China’s imports of refined copper were recently reported up 149% percent from April to April and soybeans are getting into the act with China increasing imports of the high protein source of Tofu by 55%. Even lowly iron ore imports are up 24% YoY.

Although we might be driving less, or at least using less fuel while doing so, the Energy Information Administration has just revamped the way in which coal reserves are calculated and while still many years down the road, what used to be considered 12 generations of coal reserves has been greatly reduced by adding just a bit more precision to the inventory process. The Gillette coal field, the nation's largest and most productive, was recently determined by the U.S. Geological Survey to have only 6% of its biggest beds able to be mined profitably at prices higher than today’s.

Where does this leave us? As always, looking at the CDS market for clues. Those clues are lower CDS levels at the moment and these are being confirmed by higher equity prices in those names. What are “those names” you ask?

The CDS/equity relationship has the CEC Portfolio long all three of the coal names: ACI, BTU and MEE. In the drilling space DO, NBR, NE, PDE and RIG. Additionally explorers like: NFX, NXY and TLM. In the metals: AA, AKS, FCX, NUE and X.

To give you CDS equity history for all of these names individually would stretch this piece for another few pages at least. The take-away is that when you sift through all of the news and conflicting opinions the CDS market believes that the balance sheets of a good number of the commodity related companies will be improving and to the extent that the CDS/equity relationship holds, this can lead to higher prices for the stocks of those same companies. Obviously this is not a recommendation and there are no guarantees in the market place, or anywhere else for that matter.

Comments

[Larry House:]

If you have to take a paragraph to explain your allusion, you should choose a different one. I just don't get anything useful from the piece.

Jun 11 12:01 PM