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there is some new projection about how high oil prices are going to go or how the U.S. economy is slipping deeper into a recession; some have even begun comparing the current state of the economy to the Great Depression. This article will show the hopeful silver lining to that cloud over Wall Street.
Crude Oil: Oil prices are up about 85% year over year and the main reasons being cited are the supply/demand discrepancy, the weaker dollar, political unrest, and the fact that emerging economies are drastically increasing their demand. We will look at each factor individually, but we do realize that each affects the others as well.
Let's address the supply/demand issue first. Yes, emerging economies such as China, Russia, India, and the Middle East are using more oil than five, ten, and fifteen years ago, but are they using 80% more? Additionally, experts say that all the "easy oil" has been found, but oil is still bubbling to the surface in the Kurdish region. Brazil recently found an oil reserve off its coast that could potentially hold 33.0 billion (yes with a "B") barrels of the black stuff and would be the world's third largest oil reserve. Additionally, this reserve would surpass the 21.8 billion barrels of proven reserves that the U.S. currently has at its disposal. Surely, a find such as this would improve the perception of the supply end of the formula. As oil prices have spiked above $130 and then $140 per barrel, governments across the world, which had been offering subsidies to their populations and refiners, have begun to lessen those subsidies, which should prove to slow the increase in demand. China's oil subsidies were cut by 18% in June, which some say isn't enough, but if oil prices jumped 18% overnight, there would surely be a large backlash (not to mention a Congressional "investigation"), and a subsequent drop in demand.
To me, it looks like the bubble has moved from tech stocks at the early part of this century, to the housing market, and now onto commodities. Will oil see as dramatic of a drop as the tech sector did following its historic collapse, or as the housing market is in the midst of seeing, or even as the correction following the oil crisis of the late 1970s? My answer is probably not, but even $100 or $90 for a barrel of oil would be welcomed with open arms and a bottle of champagne.
click to enlarge
Next we will look at the weaker dollar. The dollar has been declining compared to the Euro for the better part of the last two years and oil, as the two-year chart above shows, has seen a drastic change since August of 2007. The following chart shows how many greenbacks one Euro would purchase.
While the charts are similar, the abrupt increase that we see in the oil chart is not present. For days, as oil spiked and the dollar weakened, talking heads on television said the rise in oil was a result of the weakening dollar. However, it appears that the tail is now wagging the dog, as the dollar has reacted to the price of oil instead of the other way around. Economists say the weaker dollar has caused oil to rise, and that the price inflation is affecting the strength of the U.S. economy (and the world for that matter), and possibly leading to recession. Denmark is officially in a recession and Spain, Italy, and the United Kingdom are flirting with the dreaded "R" word. When thinking about the weaker dollar relative to oil prices and inflation, it would stand to reason that as economic growth around the world begins to feel the pressure from inflation oil prices would move lower. However that has not been the case as a slower U.S. economy has led to a weaker dollar which has pushed oil prices higher and thus an even weaker U.S. economy; and the cycle continues.
Finally, we have political unrest. There is always some sort of rhetoric being pushed around that sends oil prices higher, whether it is Iran firing test missiles, talk about an inevitable invasion of Iran, anti-American talk from Venezuela's Chavez, or terrorist (sorry, rebel) attacks on pipelines in Nigeria. Some sort of political unrest premium is being worked into the price of oil, but has anyone realized that the political unrest even in times of relative calm rarely comes out of the price? It only adds upon the last scare. It's really not a question of if, but when for all these cataclysmic events to occur.
State of the Economy: The doomsday predictions about the state of the economy have taken a back seat lately to $200 oil and $7.00 gasoline, but the undertones are still there. As we enter this next round of earnings releases it will be interesting to see how the market reacts to those multinationals that continue to perform well. For instance, take the railroad industry; higher fuel costs and a slowing economy were expected to eat into volumes and pricing power, but that has not been the case. Exports have continued to drive the sector, with coal and grains leading the way. Despite a continued slowdown in the housing market and drastically fewer shipments of automobiles, total carloads are higher year over year with ton-miles up 1.5% year to date. The economy has yet to "officially" slip into a recession, but everyone from Wall Street to Main Street is feeling a pinch.
Yesterday morning, Wal-Mart (WMT) reported better than expected results for its sales during the month of June and raised its earnings estimates for the second quarter. Pundits will say it was a stimulus-check-induced bounce, but the strength at other retailers such as TJ Maxx (TJX) and Ross Stores (ROST) show that Americans, despite higher fuel and food costs, were still spending money, even before the checks arrived. Perhaps the biggest highlight from Wal-Mart's June sales figures was the jump in the home category, which had been languishing for the better part of two years.
All in all, despite officially entering into bear market territory, Americans aren't crying uncle. However, the real lynchpin for this market to turn around (and economy for that matter) is the financials. Rumors of additional write-offs and insolvency are the name of the game, and until the financials can shore up their balance sheets and right the ship, it won't matter how well the other sectors do as the market will continue to have the weight of the financial world on its shoulders.
Call me a bull, call me optimistic, call me whatever you would like, but I don't think the economy is as bad as the media is making it out to be. Yes, Americans are having to change their habits, yes there are rumors every day about another company on the edge of bankruptcy, but the fact remains that the unemployment rate is at 5.5%, and until a few years back, that was considered full employment. Which brings us back to the financials; if the CEOs of JP Morgan (JPM), Jamie Dimon, Bank of America (BAC), Ken Lewis, Citigroup (C), Vikram Pandit, and Lehman Brothers (LEH), Richard Fuld, can get their respective acts together and begin to change public opinion, then the rest of the economy will fall into place like dominoes.
Written by David Silver, a Research Analyst for Wall Street Strategies (www.wstreet.com) covering companies in the Transports, Autos, and Beverage sectors.
Disclosure: none
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This article has 31 comments:
By Jan 2000 Yahoo was up another 1500%. Total advance 15,000%.
This commodity bubble can go much higher.
If we look at a sampling of oil company PEs today.
XOM = 11
CVX =11
COP =12
DVN =13
COSWF = 14
MRO =8
BP=9
Even the new players are well within the historical PE range of 10 to 20.
PBR =18
PTR =11
I don't see any bubbles here (within the company's themselves).
The US dollar's decline has contributed 33% to oil's increase. If we look at the price of oil in Euros for the last 6 years, it still tripled (as opposed to a 6X in increase in USD). This clearly indicates supply and demand imbalance is the primary factor in oil price increase.
Yesterday, Canadian currency's strenghtening.
Wouldn't CAD reach $106.250 & AUD reach $103.250?
"Price" of oil. That's easy, that's the market price.
"Earning" of oil, at the very end, is how much oil really benefits the person who ultimately buys it. Who's that? Yup, consumers.
Earnings hasn't gone up this much (80% appreciation). The "utility" I get out of a gallon of gas or a stack of plastic or a gallon of heating oil, or a ball of wax, hasn't really moved up.
Prices, however, has gotten out of hand. 80% increase.
So to say P/E ratio hasn't gone up is wrong. It's been climbing steadily or almost doubling. And there's a limit...
Gradually (it's not a fixed price point, it's a sliding scale) oil's "Earnings" to me exceed it's "Price" to me, so I will do something else (If I am Rational). I walk, shop closer, re-use, substitute, etc. There going to be some lag time, as certain things in life is a force of habit, technology and inertia, but at some point the market will change.
I agree, P/E ratio is an indicator of bubble. We're not close to bursting yet, but don't use it to claim that oil isn't a bubble.
I mentioned the PE ratios to illustrate that oil company stocks themselves are not overpriced.
The utility you and I get out of a barrel of oil has not increased 6-fold, I agree.
But we are now competing with people in China, India, Russia and Brasil who did not want that utility 10 years ago, but want it now.
The use of oil is so ubiquitous, substitution away from it will be extremely difficult. It it will take a minimum of 30 years to move away from oil based transportation to something else. Oil is heavily used in plastics, fertilizer and other petrochemical products. I don't see any serious research being done to substitute oil in the petrochemical arena.
American consumers were too dumb to realize the simple fact: you can't spend more than you make over a long period of time and come out ahead. And as many homeowners found out, those ARMs they took out in 2002 and 2003 are beating the crap out of them now.
Our economy is in bad shape - consumers are 70% of it, and they're getting hammered. When you have a currency that's barely worth the paper it's printed on and a country that doesn't manufacture anything anymore, it's little wonder why a financial services collapse will obliterate the market.
I can see oil at $165 by year end and the S&P at 850 by February. There are still millions of foreclosures to come.
What are the chances that students who cannot find jobs default on unforgiveable student loans and carry that $100k+ debt load forward w/interest for their foreseeable futures?
I'm a bear on the US ecomomy today, but why do people keep repeating this falsehood?
We are 5% of the world's people making 20% of the world's manufactured goods in dollar terms. We don't make the stuff you buy at Walmart, we make airplanes and computers and cancer fighting drugs and lots of other stuff (including Toyotas and BMW's).
We make them with much less labor per dollar of goods produced than you can make a towel or a plastic toy. So many less people are employed in manufacturing, but they have the world's highest productivity. One person in a high tech automated factory can produce a lot more (in $ terms) than 100 people sitting at sewing machines.
I think we agree on most of this...bearish...less manufacturing jobs in the US...middle class in deep trouble...
But we still manufacture more than anyone one the planet (measured in $ not lbs.)
Besides, as a rule, PEs don't show value; they show popularity. The dotbomb blowout was indeed a true bubble, because there were no assets or earnings; but the oil companies have both assets and earnings. But their earnings have ballooned recently to unusual highs, and before long those earnings must revert to the mean.
Right now the main thing holding oil up is fear of an Israeli invasion of Iran.
At first I thought it was a wolf ticket, because they've never telegraphed an attack in the past; but after reading the article below yesterday, I've changed my mind: either the Israelis will force the US to bomb Iran, as they did Iraq, or they'll do it themselves.
Oil and gold stay high until that mess is settled, and stocks must stay in the doldrums.
See this article, "Will Israel Strike Iran" here:
www.humanevents.com/ar...
The author seems to misunderstand the basics of how supply and demand imbalances effect prices...when then question how crude oil prices could be up %85 in a year by asking:
"Yes, emerging economies such as China, Russia, India, and the Middle East are using more oil than five, ten, and fifteen years ago, but are they using 80% more?"
When buyers outnumber sellers, even by only a little bit, prices rise. How much prices rise is not a function of the number of extra buyers -- but rather a function of how much the buyers are willing to pay to beat out their rival bidders for the scares commodity.
I have seen many forms of this argument over the past month, which claims supply and demand can not possible be the main price driver -- before moving on to crazy theories of why the new price is "wrong" or a bubble must have formed.
Price bubbles form when buyers hope for a greater fool to pay even more then they have paid for a hot commodity. But in this case the greater fool is you and me...when we fill up with $4 a gallon gas. This is not a case of speculators hoarding oil hoping someone might pay more someday for it-- that day is here now.
IRA...
Swiss francs (FXF)
GLD
DJP
TIP
FLVCX ( FIDELITY LEVERAGED FUND )
Taxable..........
FCSTX ( Fidelity short/intermediate muni fund )
CGMFX ( Ken Heebner is the best but had a big payout in December )
NO STOCKS EVER
KEEP IT SIMPLE AND ALWAYS BE PREPARED TO BAIL OUT !!!!
Just look at past history to see how non-linearly prices respond to small supply and demand imbalances. The sensitivity to small change is quite pronounced.
1973-1974: Arab embargo takes only 5% of oil off the global market, but prices go up five fold from 2$/barrel to $10/barrel
1979-1981: Iran-Iraq war takes 10% of global oil off the market.
Prices go up another 4 fold from $10/barrel to $40/barrel.
1983-1985: North Sea, Canterall and Prudhoe production in full swing which gluts the market with 20% spare capacity. Prices drop from $40 to $10 per barrel.
2003-present: Global oil production plateaus at 85 mbl/day, but demand continues to increase from BRIC and ME countries. Oil is up 7.5 fold.
Real Estate is not used up days within being purchased.
If oil is such a bubble, where are the huge stocks building up?
Obviously someone's buying it and using it at today's prices.
There are many complex factors at work, but world demand is rising fast and the dollar is dropping. Till those trends reverse I wouldn't look for anything but a temporary downward move in oil prices.
Don't you guys even know who Ron Paul is? Geez people, he has been telling your forture FOR 30 YEARS. Would you just go do some research on the man and his message before its too late for the USA?
This government has failed us and even though we should drill for oil in places like off shore, this will be temporary and may give us more time to build up alternative energy. Most of the American population (I am a citizen) are fools. They never want to do something becaue it will change the future, just get the most now. Once the results of bad decisions happen they is an outcry of how can this happen? I have tried to talk to a number of people about issues, none will listen (this does not include most people on these boards who are concerned). I have suggested reading books like The Long Emergency (Kunstler), Confessions of an Economic Hit Man (Perkins), etc. There is no response to my emails. These are mostly highly educated people.
Over the next decade the US will have to change dramatically and to reduce oil imports we must get on some other fuel. Hybrid cars will be the first step. Hydrogen, may be the second. Those that say that hydrogen is just a storage medium are like someone stating a few pounds of Uranium can't possibly produce much energy, just look at how much coal it takes.
We must hold down population as well, there is too much immigration and too many groups that have large families. We are invaded by illegals and now, because of the Latino groups like La Raza, the Catholic church and business groups, our border has been open for far too long. Yes, many Americans are fools.
peakoildebunked.blogsp.../