QE's Effects On Brent Larger Than U.S. Supply Growth

Includes: BNO, FXY, GLD, SPY
by: Tom Luongo

On New Year's Eve, Adam Levine-Weinberg posted an article on Seeking Alpha entitled "Why $100 Brent Will Not Last Through 2013." It is an excellent run down of the fundamentals of the changes happening within the U.S. oil production and infrastructure markets. I agree with much of Adam's analysis. What I disagree with, and said as much in the comments, are his conclusions and title. I do not see Brent Crude below $100 per barrel in 2013 except on a spike down on fear, which would be quickly bid back up.

I'm writing this on the Day We go Over the Fiscal Cliff and while the markets are reacting to the 'will they/won't they' press statement games being played by the sociopaths on The Hill, Brent Crude is trading at $111 per barrel for February delivery.

The United States Brent Oil ETF (AMEX:BNO) closed at $82.07, or the high for the month, just $0.02 shy of the November high and $0.08 shy of the December high. This is a very powerful bullish trading setup for January. A move above the December high would create a high probability for a move past $85 in January which would coincide with a move in Brent Crude back over ~$117 per barrel.

My point here is that the fiscal cliff has had ample opportunity to have been priced into the oil markets. Whereas Gold (AMEX:GLD) has been beaten backwards to create, wrongly, the impression of upcoming deflation and recession, oil prices have held up well in the face of it. So, by the way, have Corn, Wheat, Cattle and Soybean prices, just to name a few.

The Open Spigot Policy

In my comments on Adam's article I brought up the potential effects of unsterilized QE on the price of Brent:

Through (Sic "Throw") in more than $1 trillion in QE and a Euro moving back to $1.40 and the price of Oil will rise sharply. The Saudi Arabians cannot and will not continue production at near 10 Mbpd in the face of increased U.S. Exports.

I see the supply shifting around but not significantly increasing and demand will hold or move higher. But, we'll see. I'm not insanely bullish on oil in real terms short-term but I am bullish on it (sic) nominal terms. Unsterilized QE is a boon to oil prices and the Fed is bound and determined to get money flow and higher CPI inflation.

To discount the effects of unsterilized QE at $85 billion per month on the nominal price of oil is a serious oversight in analysis. All things play into the price of oil. At this point, I don't expect global GDP in 2013 to be much better or worse than 2012 and Brent crude rose 3.9% this year. Mind you, this was in the face of a full-on depression raging across most of Europe, massive slowdowns in China and India, a recession in Japan and Singapore and 18 months of relatively tight monetary policy by the U.S.

In the past 4 months, the major central banks have all gone into a coordinated round of unsterilized QE, the magnitude of which has never been seen before. The Japanese have debased the Yen (AMEX:FXY) 12% in less than 2 months. Below is a graph of the SPDR S&P 500 ETF (AMEX:SPY), GLD and BNO along with notations of when the Fed's various QE programs have started and stopped. As I noted in my article last week, total Fed Credit in the week ending 12/16 was the 2nd highest weekly positive change since the Lehman Bros. failure brought on all of this QE nonsense. And the last time that amount of Fed credit was created that quickly, mid-December 2011, Brent Crude went on a run from $103 to $125+ per barrel before it was stymied by a violent reversal of monetary policy by the Fed on February 29th.

In short, if the fear of the Euro-zone breaking up, very tight monetary policy and the threat of a hard landing in China's property markets couldn't break Brent below $90 per barrel for more than a couple of hours back in June, I just don't see how a bit of more marginal supply from the U.S. will shave 12% off in 2013. The Saudis ramped up production to break Iran but they don't have to maintain that pace forever, and if they do, it'll be because the demand coming out of places like Southeast Asia will pay them to do so.

The Golden Ratio

The last chart I have is the Gold to Brent Ratio which I feel is very relevant, especially considering the considerable amount of Iranian oil that is being paid for with Turkish gold at the present time. This is a 3-year weekly chart. Note the 50-week moving average is right at 15 barrels per ounce of Gold which is where the price is today. For traders, I would use this as a confirmatory signal to anything your technical or quantitative analysis is telling you. Above 15 and Gold is over-valued relative to oil and vice versa.

If you are bullish on the price of gold, which I am, then at these valuations you have to be bullish on the price of Brent Crude, because right now the two are trading at about as close to a stable relationship as they ever have. Even if you are not bullish on Gold, at a 15:1 ratio -- and I'm not open to arguments against that ratio with a 50-week moving average flat-lined for 6 months at that level -- that would imply a move to $1500 per ounce after multiple, violent attempts by the central banks to break gold down to that level over the past 18 months and have failed to breach even the $1525 area.

In an age where fiat currencies are being actively debased in a major trans-continental Currency War pricing, the world's most important commodity in terms of the only money without counter-party risk should be the basis for one's analysis not tossed in the garbage.

The Stock is the Flow

My last point is a subtle one which is part of the monetary stock and flow argument. It is no secret that the petrodollar system is breaking down. China is now openly trading oil in Yuan. Most of Southeast Asia is on a Yuan standard. Every barrel of oil not paid for in dollars is a dollar of inflation that is not soaked up by the oil markets. Hence, in order to maintain the same number of dollars flowing through the oil markets, the price of oil has to rise to soak those dollars up. The petrodollar system is still needed to keep the international demand for the Dollar manageable. So, basically, the U.S. needs higher oil prices going forward to control the Dollar's devaluation.

Moreover, as the U.S. becomes a stronger exporter of oil and petroleum products what price do you think the oil producers and those miscreants on The Hill want to sell it for -- the lowest or highest possible price? Which one generates more tax revenue?

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.

Additional disclosure: I own physical gold and silver.