The Pause That Refreshes

Jim Brown
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The long awaited pause for profit taking finally arrived. Now the only question is where will it stop? Is this a dip or a correction? Is it temporary or will it last for weeks?

The correct answer to all those questions would be worth their weight in gold. It would have to be digital gold not the real thing since answers don't weigh anything. After the beating gold has taken this week we might want to take our rewards in platinum or palladium instead. Gold has fallen from $1615 the prior week to $1550 today. More on this later.

Crude oil fell -$2.72 after the ISM Services Index for March came in sharply lower at 54.4, down from the 56.0 in February. That is a big move in ISM terms. Employment declined -4 points to 53.3 and new orders fell nearly -4 points to 54.6. Export orders fell -4 points to 56.5. It was not a good month for the services sector. Analysts were quick to chalk it up to the sequester and lower government spending. That will be the gift that keeps on giving for months to come.

Also weighing on crude prices was a sharply lower number on the ADP Employment report for March. The report suggested private sector job creation was slowing. The headline number showed the addition of +158,000 jobs compared to the upwardly revised +237,000 jobs they claim for February. The January number was revised lower from +215,000 to +177,000.

The ADP report caused analysts to lower their numbers for the Nonfarm Payroll report due out on Friday. Estimates were for a gain of +200,000 and they are dropping into the 160,000-175,000 range. Fewer jobs means less oil demand.

The third event weighing on prices was the weekly oil inventory report from the EIA. Crude inventories rose +2.7 million barrels to 388.6 million. That is a 23 year high. Not since July 1990 have inventories been this high. This is a testament to the decline in demand in the U.S. rather than the rise in production. Refiners have cut their imports significantly to less than 8.0 mbpd from their recent highs over 10.0 mbpd in 2008 and more than 11.0 million in 2006. The chart below shows the difference in imports in just the last year.

Oil Import Chart

The high unemployment in the U.S. means far fewer people are driving to work every day. There are fewer workers today than there were when Obama took office and the number of people on food stamps has nearly doubled to 48.7 million. Workers on disability have jumped from 5.0 million to more than 14.0 million in four years. When your unemployment insurance runs out a lot of workers began to claim disability instead. Anything to get money from the government until they can find work.

The official government numbers claim there are 12.03 million unemployed workers. However there are 18.91 million working part time because they can't find a full time job. Add in another 2.59 million "marginal" workers without full time work and 885,000 discouraged workers that have given up looking and you have 34.68 million people looking for full time work or would take a job if one was offered. How much gasoline are these people not consuming by not going to work at a full time job? It is a lot. If each one only consumed five gallons a week that would be an extra 500,000 bp week and you know most workers consume well over five gallons a week. Two to three times that would be more reasonable.

That makes news of a decline in hiring a negative for future demand and prices fell on the news.

The active gas rig count at 389 for last week is a 13 year low.

Inventory Snapshot

Oil inventories would have been higher but imports declined -277,000 bpd for the week. Inventories are +7.2% higher than the same week in 2012.

Distillate inventories fell by -2.3 million barrels and the second big decline in two weeks. This is heating oil replenishment and jet fuel distribution after the winter storms faded. Distillate inventories are still a whopping -16.9% below year ago levels.

Gasoline inventories fell by a minor -600,000 barrels to continue their spring decline. Remember, this is due to refiners letting winter blends sell out to make room for summer blend gasoline. This is a seasonal event and nothing to be concerned about.

There was nothing in this report that a knowledgeable investor reading these pages would not have know already. Crude levels build in the spring, gasoline declines for seasonal reasons. It was definitely not a reason for WTI prices to decline almost $3.

Oil Inventory Chart

Gasoline Inventory Chart

Distillate Inventory Chart

In theory there are a lot of hot spots around the world that investors should be watching for problems in oil production and transportation rather worrying about the ADP report in the USA.

In Iraq production is slowing as sectarian violence increases and U.S. companies are pulling out rather than try to increase production from the potentially prolific fields. Iraq has the second largest oil reserves in the Middle East but meeting their aggressive production goals is proving tough to do. The Kurds in the northern part of the country are at odds with the Iraqi government over who owns the oil in their land and how payments are to be made. The Iraqi government is becoming more unstable and is allowing Iran to exert more control. Chinese oil companies are taking over the exploration and production tasks because loss of life is less important to a government owned enterprise.

Iran could be attacked at any time. It will probably come late in the summer but military strategy dictates you never attack when expected. That means it could come at any time. If attacked Iran has threatened to attack oil fields in the region in retaliation and close the Strait of Hormuz. This should be a major worry to investors that don't own oil assets.

Libya is becoming more unstable as each day passes. The hundreds of militias are holding oil installations hostage in some cases and the rule of law is nonexistent. The country could fall back into civil war at any time and oil production cease again.

Nigeria is suffering from oil thefts, pipeline damage and the MEND rebels just announced a new round of attacks on oil installations if their demands are not met. Oil deliveries have already been slashed and Shell had to declare force majeure on Bonny Light crude.

Algeria is still a hot spot after the gas plant occupation. There is uncertainty in the region and businesses are cautious about the future. Al Qaeda is increasing its presence and civilian unrest is growing.

In Egypt the country is about to go bankrupt. Morsi is failing at putting the country back together after the Arab Spring revolt put the Muslim Brotherhood in power. Tourism has dried up with increasing attacks on Christians. Inflation is soaring despite price controls on most common products like bread and diesel. The black market is selling products at 2-3 times the official price. Hard currency has dried up and Egypt has plundered the treasury to the point where foreign currency reserves are only 25% of year ago levels and dropping. Egypt is trying to borrow billions from the IMF with little success and unemployment is more than 25%. Youth unemployment is approaching 50%. The Egyptian military is in control of the Suez Canal where oil tankers transit daily. Another civil war could cloud that issue.

In Venezuela the pending election should put Nicolas Maduro into power as Chavez wanted but he may be even more socialist than Chavez. The oil sector is drying up for lack of capital to repair existing facilities and expand production. The government is taking all the cash produced by PDVSA and leaving none to operate. Venezuela has large oil deposits but they have run all the majors out of the country and owe them tens of billions in reparations. The outlook is not good.

North Korea is not an oil producing nation but they are on the verge of causing a significant war that will impact global economics from a sentiment perspective. China is their protector but China can't keep them from twisting the tail of the U.S. and provoking a war. There was another announcement today claiming the military had ratified the dictator's war plans calling for preemptive nuclear strikes on the U.S. and South Korea. We all know this is a bluff but eventually they could start believing their own propaganda and do something stupid. The U.S. announced today it was moving missile interceptors to Guam to protect the country from North Korean missiles. The U.S. is also moving additional guided missile ships into position around North Korea to be prepared for an exercise in stupidity by Korea. One Aegis equipped cruiser could eliminate anything of importance in North Korea without breaking a sweat. For the dictator to be teasing the U.S. is the equivalent of a mouse teasing a lion. That will be the case until Korea gains the ability to actually put a nuclear weapon on a missile. Experts believe they are two years away. This means they are less than two years away from having that capability taken away from them by force. Korea may not be an oil producer and barely an oil consumer but it is still a headline on the global stage that could impact prices.


Exxon (XOM) was forced to close the Pegasus pipeline, which transports 90,000 bpd to Texas from Illinois. The pipeline sprung a leak in Arkansas about 20 miles north of Little Rock. Up to 5,000 barrels of crude may have leaked. The pipeline is buried and the oil rose to the surface in a residential neighborhood. Exxon has given officials a plan on how they are going to dig up the line and replace the damaged section. They have not yet received approval from regulators. The challenge is that Exxon does not know why the pipeline ruptured. Once they dig it up and study the cause it could result in a larger effort and keep the pipeline closed for a long time. A late news item claims regulators are going to ask Exxon to move the pipeline away from the residential area and Lake Conway right next door. That would shut the pipeline for a LONG time.

In separate news Exxon and BHP Billiton are planning on developing a huge floating LNG plant offshore Australia. The gas would come from the Scarborough field and be expected to produce up to 7 million tons of LNG per year. Exxon and BHP are going to have the design and engineering work completed by 2015 and make the final decision on implementation in order to see first production by 2021. Royal Dutch Shell is already building a floating LNG vessel estimated to cost $12 billion and produce 3.6 million tons annually. Chevron and its partners are investing $52 billion for the construction of the Gorgon onshore LNG plant to produce 15 million tons annually.


The federal judge in the BP spill trial dismissed all claims against Cameron International (CAM) the manufacturer of the blow out preventer used on the Macondo well. The judge said the data points "not at Cameron itself but rather at Cameron's customers in this case," BP and Transocean.

Gold & Silver

It is buying time again on the precious metals. Bearishness has reached extreme levels and prices have declined to strong support on both gold and silver. The bears are claiming there are no fundamental reasons for owning gold and silver because the U.S. economy is slowly improving and interest rates will be rising. That makes it more expensive to hold precious metals as a hedge against inflation and uncertainty.

I ask you, are you more certain about the direction of the economy? Does the potential threat of an attack on Iran and the immediate terrorist backlash cause you any concern? Does the deepening recession in Europe give you a reason to worry about the global economy sinking as well? Is the equity market headed for a correction? I could go on but you get the idea.

Buy when nobody else wants to buy. Buy when even you don't want to buy.

Gold Chart

Silver Chart


The Dow gave back -111 points today but that was just slightly more than it gained on Tuesday. The Dow is not the index of choice to determine market direction because of its limited breadth. The Dow declined to 14,550 and that was resistance just three days ago so only looking at the Dow would give you a false impression of the market.

The S&P gave back -16 points but closed above support at 1,550 that has held for three weeks. This market dip would appear to be just a hiccup if you look at the S&P.

The true market indicators are the Russell 2000 Small Cap Index and the Dow Transports. The Russell has already declined -3.5% from Thursday's closing high and has broken below critical support. The Russell is the index of choice for fund managers moving into the market at the beginning of the year. The Russell rose from 763 at Thanksgiving to 952 last week or roughly a +25% gain. That represent a an entire years gain or even a couple years gain for some fund managers. They have to be looking at the declining economics and deepening recession in Europe and wondering if they should be taking profits now and wait out the summer doldrums.

The earnings estimates for the S&P-500 for Q1 are dropping like a rock. They have gone from +0.58% to -1.9% in just the last week. That would be the first negative quarter for earnings since 2009. This should be giving fund managers a cause for concern.

Russell 2000 Chart

Nobody knows if the decline will continue. There are plenty of reasons to suggest it is time for a correction but bulls die slowly. The topping process does not happen overnight. However, in the chart above we spent three weeks struggling to make a new high and the consolidation eventually failed.

If we do decline to the 900 level on the Russell I will be a buyer. Whether I remain a buyer depends on that support at 895 and if it holds.

I believe we are going to get a decent "sell in May" decline this year and fund managers may want to skip April all together and just get to the sell part to lock in profits.

I would be cautious about new longs in the market until we see a bottom.

Jim Brown

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