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Just a Commodities Correction - Not the End of the Bull (Part 1)

by: The Society August 19, 2008 | about stocks: DBC / DJP / GSG / OIL / UDN / USO / UUP / XLE    

The Sovereign Society

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By Eric Roseman

Every single day, the world's population uses more oil than the planet can possibly produce. This means the peak oil theory is still alive and well.

That's why this ongoing correction in crude oil prices is creating the best entry point for new investors in more than three years. Right now, most companies trade at or near their 52-week lows and pay some fat dividends higher than both the broader market and Treasury bonds.

Poor Correlation on the Way Up

The majority of energy stocks have struggled this year as oil prices raced to a record high of US $147 a barrel. Stocks simply couldn't rally as the bear market in global stocks applied downward pressure on the entire complex.

Oil futures tell a completely different story. While major U.S. and international oil companies rose only 3.5% from January 1 to July 11, oil futures rose an astounding 63%. Over the same period, the S&P 500 Index tanked more than 10%.

Admittedly, the recent peak in oil prices was extreme and indicated a short-term "bubble."

Commodities have been the prime beneficiaries of the global institutional boom. Industry players have already created a flurry of exchange traded funds to take advantage of this commodity bull market.

Also, hedge funds have turned to commodities to gain exposure to one of the few remaining profitable segments of the market. In fact, hedge funds' "big trade" over the last 12 months has been riding the wave in commodities, including oil and shorting or betting against financial stocks. That trade violently reversed last month.

Another dose of bad news for commodities lately is the dollar's rapid recovery. With the dollar in a freefall over the last few years investors had scrambled to hedge their portfolios against rising inflation and a decaying currency. But that trend is over, at least for now.

Bear Market or Correction?

From its high in early July the benchmark Reuters-CRB Index has declined 19% while crude oil prices have tanked 23%. Other commodities have declined even more.

Oil stocks, as measured by the Spiders XLE Index (XLE) are down 22.5% from their highs while the Dow Jones Oil Equipment and Services Index is off 21% from its best level.

Commodities, including oil, are in a correction. But don't be mistaken: We're definitely not at the cusp of a bear market for oil or commodities.

The market is right to discount a slowing global economy this year as credit problems and stagflation spread to overseas economies. It's wrong to assume that the bull market in oil and most other commodities is over. Short-term cash rates still below the rate of inflation and global money-supply is still growing in excess of almost 20% year over year, according to Grant's Interest Rate Observer.

In its fight to control deflation in housing and bank credit, the Federal Reserve will continue to pump the financial system with more money. Massive government bailouts don't come cheap. Over time, inflation, which is now moderating, will make a comeback.

And What About the Dollar?

Just because the dollar is soaring doesn't imply that trend will last, either. The Fed is not going to hike lending rates for at least another 12 months and foreign central banks won't start cutting rates until inflation eases.

The dollar may be in a bear market rally now, but the buck simply doesn't have interest rate support from the Fed. Plus, the economy remains mired in a severe slowdown or recession across several important industries.

$WTIC

At the very least I expect the rate of dollar appreciation to slow over the next few weeks as profit-taking arrives and more signs of credit contraction plague the domestic economy. If anything, I'm expecting the Fed to cut, not raise, interest rates in 2009. That won't be bullish for the dollar.

Disclosure: None

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This article has 11 comments:

  •  
    Aug 19 07:05 AM
    Don't be a bull,don't be a bear,trade on a daily basis up and down and markets will decide without you where to go next.
    Usually before big Dow Jones correction commodities markets and currencies must udjust to new reality and those are volatile days that every day trader loves and waits and dreams about.
    As Dow Jones in few weeks is going to hit the wall at 9000-9500 we must adjust in our other positions,one can not make money on each trade,so we chose a short index strategyas a Klondike so losses on other mistakes will be fully covered by you being long stocks.
    Keep all you stocks,don't sell a single share as market with the help of Bernanke is going to rally 50% till December,don't sell,only buy,buy,buy.
    It was a joke.
    Reply
  •  
    Aug 19 07:54 AM
    People are just tired of using dark age fossil fuel, long time of lobbysm and bribes had delay the spread of new age technologies like electrical, hydrogen-water, etc. Now Russia playing a good game on the oil, gas supply network to Europe is driving us to think twice about continue fossil fuel to drive a car. This is too much of a headache! we need cars and trucks that work independently of oil or fossil fuel period, stop the nonsense.
    Reply
  •  
    Aug 19 09:10 AM
    Eric---You are whistling in the cemetery. The commodities have a long way down to go. We are in a debt elimination --disinflation. There is no shortage of any commodity.
    Reply
  •  
    Aug 19 09:23 AM
    drill here drill now!
    Reply
  •  
    Aug 19 09:47 AM
    Contrarians will now short the heck out of the dollar and the stock market, and go super-long on gold and silver. The first two were bloated in price, from the last few weeks worth of fake rallying, while the latter two have been pummeled. Buy low, sell high!
    Reply
  •  
    Aug 19 10:59 AM
    The slow spread of alternatives to fossil fuels has little to do with bribes or lobbying, though Big Oil certainly plays a role. But more importantly are the severe technological hurdles for, say, a 'hydrogen economy' which experts and scientists in the field predict is 40 or 50 years away. Additionally, even the terminology is misleading - these technologies are not so much 'alternatives' to fossil fuels as they are 'derivatives' of it.

    Also, there is a fundamental distinction to be made here: fossil fuels are almost unbelievably energy dense - most of the 'alternatives' are, simply, not. And there are no good substitutes for liquids replacement that offer anywhere near the ERoEI metrics of traditional fossil fuels, and the ERoEI for fossil fuels going forward looks set to drop rather dramatically.

    There is no magic wand - there is no 'switch' we can simply flip. And given that we do not have a free market, but rather a heavily regulated, subsidized and politicized market which operates under the burden of profound market distortions compliments of both the government and non-governmental entities like the Fed, you cannot expect 'market forces' (which are heavily suppressed) to come to the rescue.

    Additionally, while human ingenuity is a marvelous thing, it is *not* a miraculous thing. If it were, we'd have solved the battery problem decades ago, dontcha think? Not like there haven't been really smart, really motivated people working on this particular challenge for years and years and years - and with the dollar incentives involved, it's hard to see how any additional level of motivation would make a difference.

    In other words, this is not a simple problem to solve, and it may in fact be the most difficult problem to solve that modern humans have yet faced, and there are no guarantees that we *will* solve it. In the current political and socio-economic climate, it certainly seems the odds are stacked quite heavily against us.

    It seems possible that what we face is, in fact, not a problem in search of a solution, but a new condition to which we will need to adapt. Or not.
    Reply
  •  
    Aug 19 11:02 AM
    To: PHILMAN

    You see, you get it. It befuddles me that so many out there can't see the forest because the biggggggg trees are in the way!

    After I finish typing this, I am heading for my local precious metals shop and relieving them of whatever gold AND silver they have!

    Sonofabitch, it is so simple to see what is happening:

    Government out of control spending
    Government money making machines going 24/7
    Personal debt skyrocketing
    Financial markets being manipulated by greedy, egotistical crooks
    Geopolitical atmosphere is bleak (Iraq, Iran, Israel, Afganistan, North Korea, etc)
    Reply
  •  
    Aug 19 12:24 PM
    sell stocks and go to cash which is the u.s funny money. put it under the mattress then you'll live happilly ever after!
    Reply
  •  
    Aug 19 12:45 PM
    To ishortyou,
    Nice wish list. Wake up to how long and at what cost your dreams will require to be significant. Meanwhile, get used to paying lots for gas, or start conserving.
    Reply
  •  
    Aug 19 02:15 PM
    Maybe population uses more oil than the planet can produce but the TRUE is the planet can't support a sharp increase in oil price, especially USA.
    That's why for every increase in oil price dollar go down keeping a more reliable price for the commodity and keeping oil cheaper. But that's not all, inflation increase is another story telling the planet can't support the price of oil, so if oil rise everything else rise making the oil price increase useless.
    People realized this and oil dropped, you guess, with a dollar rally :)

    Price of oil it's just a speculation, it has nothing to do with the real economy.
    Reply
  •  
    Aug 19 09:23 PM
    "If anything, I'm expecting the Fed to cut, not raise, interest rates in 2009. That won't be bullish for the dollar."

    i would like to see some evidence to support this.
    Reply
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