Anemic Labor Economy And Supply Suppresses Crude

 |  Includes: CVX, DIA, HAL, SLB, SPY, USO, XOM
by: Bio Insights

Last Friday (September 7), we saw very weak early trading for crude as the shockingly low number of non-farm payrolls added in August (96,000) burned into the market's psyche. Still, taking into account words from the Federal Reserve, bad news can be good news. In his recent speech, Bernanke expressed frustration at slow growth in the U.S. economy and stated (again) that the fed is watching and is fully ready to buy bonds if needed.

This, on top of uncomfortable standoffs in the Middle East and other less significant factors, has driven crude to about $96/bbl - about 12% higher than it was three months ago. Crude has certainly gotten popular again.

The supply side of oil remains quite strong despite the disruptions from the big OPEC exporter Iran, which has caused world leaders to talk about making withdrawals from strategic reserves to keep fuel prices tame (especially in the U.S., since we've got the elections coming of course). There is also pressure for other exporters to up production, which is an increasingly attractive strategy given oil's rally.

According to the EIA, U.S. stocks are actually looking quite robust going into September. Below is a graph of this year's supply along with the ranges that have been set in the last five years.

Click to enlarge
(Click to enlarge)

As you can see, we haven't really needed to use much and we've swelled it quite nicely with our record production figures. With about 360 million barrels ready to suppress oil prices, and with no severe disruptions in OPEC production on the way, the supply side says the rally has gone too far and needs a correction.

The demand side of the equation doesn't really support the rally, either. The United States (the largest consumer of oil by far) added only 96 thousand non-farm payrolls in August, and the 8.1% unemployment rate is a bit misleading.

To elaborate on that last statement, one must consider how unemployment is calculated. The headline number (known as "U3") is based on the number of people technically in the workforce that are unsuccessfully looking for work. A large number of people have been dropped out of that "actively-searching" workforce because they had stopped looking for a job for longer than four weeks.

Something called U6, which is the broadest measure of unemployment taken by the BLS, accounts for all those discouraged workers and those who would like to work more. U6 for August was 14.7%, which is only a slight improvement from last year and demonstrates just how many people are lacking income. The worst part is that a disproportionate number of those who are unemployed have been out of work for very long periods of time, which decreases the likelihood that they would find work later.

The eurozone, the second largest consumer of oil as a whole, is clearly not in a state to boost oil demand either. We can simply count them as a far more bearish influence on black gold in their current state.

Ultimately, I reiterate that unless we see dollar devaluation or an alarming event in the Middle East in the near future, the fundamentals should be enough to prevent crude from rallying past $100/bbl or so until the end of the year. If anything, we will probably see a relief rally for the U.S. dollar as stimulus hope calms down, which would be bearish for everything.

Taking this into consideration, investors may want to wait for a noticeable dip in oil prices before considering, for instance, new shares of the big energy tickers like Exxon (NYSE:XOM) and Chevron (NYSE:CVX). They've both hit 52-week highs on recent sentiment and have been overbought.

In this situation, I'd be especially cautious about drillers like Schlumberger (NYSE:SLB) and Halliburton (NYSE:HAL). They'd struggle even more on a correction due to their heightened sensitivity to oil-price correlation and a lack of decent yield that would otherwise attract some dividend investors.

If you must buy now, I think the broader market may be a wiser bet due to the large number of companies that are fundamentally unaffected by dollar strength.

There are still huge gains to be made on the long side of crude after a pullback, but I'd be a lot more comfortable waiting for a retreat to $87/bbl or so. Without any sudden stimulus or new Middle East tension, it seems like a plausible entry level to hope for.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.