Debt Deal Done

Jim Brown
 
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Crude oil prices rallied Sunday night on hopes the U.S. debt debacle was finally history but worries over a final vote in the House of Representatives and some really crummy economic numbers slammed the futures back to $94 and a low for the month.

Late Monday night the House approved the compromise agreement 269-161 with a day to spare. The Senate has not yet voted but it appears to be a done deal with more than enough senators saying they will vote for it. The White House has said the president will sign it immediately after the Senate vote.

After six months of partisan bickering, claims and counter claims the crisis may be over. The political parties including the president have used so many scare tactics against the public in an effort to sway the vote that the U.S. economy has come to a virtual standstill waiting for the crisis to end.

The threats of a first ever government default and a downgrade from AAA credit has caused investors to flee the markets and increase cash positions in order to protect themselves from future unknowns. Businessmen have also said they put a halt to hiring and slowed expansion plans as they also raised cash to increase liquidity. This potential crisis came so close to the Great Recession that memories of hard times were still vivid and nobody wanted to go down that same path again.

The economic reports over the last month have grown progressively worse. The U.S. Manufacturing ISM for July was released on Monday with a headline number of 50.9 compared to 55.3 in June. Any number over 50 indicates economic expansion and a number under 50 represents contraction. The nation came to a dead stop ahead of the August 2nd deadline. That 50.9 is the lowest level of manufacturing activity since July 2009 when the country was just moving out of the recession.

ISM Manufacturing Chart

We saw last Friday the GDP in the U.S. declined to only 1.28% growth in Q2 and Q1 was revised down to only +0.4% growth and just barely above a recession. These are not numbers that stimulate hopes about increasing oil demand.

U.S. GDP Chart

Crude oil prices should rebound on the end of the debt crisis on Tuesday BUT there is another demand destroying report in our near future. The Nonfarm Payrolls report on Friday is expected to show job growth of +85,000 jobs for July. This would be an increase from a gain of only +18,000 in June but I think those analysts are on drugs and the real number could be significantly lower.

The various economic reports over the last month have almost all shown a sharp decline in their hiring components. To think the economy added more jobs in July than June is wishful thinking unless the government decides to seasonally adjust more than normal. July is when the automakers begin to lay people off while they retool for the new models. We have also seen some rather large layoffs from banks, pharmaceutical companies and others as the economy began to weaken and the impact of new financial rules began to hit home. The government is still in layoff mode as the stimulus money evaporates and those programs are terminated. State and local governments are also cutting workers because the stimulus money quit flowing.

The reason I chose to delve into the economics behind oil demand tonight is to explain why crude oil prices may not rally as much as some would hope. Perception is the key. If the jobs numbers come in low traders will perceive a drop in demand or at least no increase in demand. We see from the EIA reports every week that gasoline demand is weak and falling.

Until we get past this nightmare in Washington and businesses and consumers start breathing easier again the economics underlying crude demand may not improve. I expect it to take 30-45 days before the regional economic reports begin to show an improvement.

That belief assumes there is not a bigger problem at work here. That problem could be simply a normal double dip recession. More often than not a major recession is followed 18-24 months later by a second recessionary dip. Businesses and consumers rebound out of the first dip full of hope and plans but the actual reality is sometimes lagging the positive sentiment.

Analysts have been telling us for months that the economy was going to accelerate in the second half of 2011. Unfortunately, for whatever reason, we are in the second half and the economy is sinking instead. If this decline continues I don't expect oil prices to implode like they did in 2008 but we could see a decline to $85. However, Asia, Latin America and the Middle East are seeing demand increase rapidly and that will be the saving grace for oil prices. Just because the U.S. is not growing does not mean we are slip sliding away in terms of demand. Declining 200,000 bpd is not the end of the world when Asia is increasing demand by a million barrels a day over the full year.

If you have investments in the energy sector I would plan on some weakness ahead. It may not come to pass if the debt debacle was the real reason for the economic slowdown but we should always plan ahead. I would view any dip as a buying opportunity because long-term oil global demand is only going higher.

Jim Brown

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