Market sentiment has definitely changed with a decline on the Dow of -216 to 14,960 and a break of support at 15,050. Crude prices rallied despite the market decline because of a monster drop in crude inventories.
We may finally be headed for the market correction everyone has been expecting. However, I would not count the market out just yet. The S&P is still in the six month trend channel and is approaching the 50-day average at 1,604. This combined support may be enough to halt the decline. Whether the uptrend resumes from there is a different question. In theory this is where the dip buyers should appear but we could see stronger support at 1,580 tested without breaking the longer term uptrend.
Of more interest for energy investors is the breakdown in the Dow Transports. The index broke below the 50-day average but the Transports have not been very reactive to that average so I am discounting that damage.
However, the Transports did break below short term uptrend support at 6,225 and we could easily see a decline to 6,000 or even 5,900 if the broader market weakness continues. The Transports are leading the decline lower with nearly a -2% drop today. The weak ISM Manufacturing report on Monday and the weaker than expected ADP Employment report today suggest the economy is slowing. That means fewer products to ship and fewer raw materials.
Dow Transports Chart
The U.S. markets have been pressured the last two weeks by events in Japan. The Japanese Nikkei is imploding with a -18% decline in the last ten days. The Nikkei declined -3.8% on Wednesday to close just above decent support at 13,000. Analysts overseas are expecting that level to break and retest 12,000.
This is perplexing to U.S. investors because Japan recently announced a more aggressive QE program than currently underway by the Federal Reserve and one that buys REITs and equity ETFs. After a sharp ride higher and a +35% gain for the year the wheels have come off the wagon. U.S. investors fear a similar event in the USA. If Japan's equity markets can crash on highly aggressive QE then why should the U.S. markets continue higher while the Fed debates tapering at every turn? Markets are forward looking and U.S. investors are seeing a slowing in QE purchases in the months ahead. They see the decline in the Nikkei as a preview of coming attractions in the USA.
Despite the breakdown in the equity market today the crude markets were positive. WTI gained +1.36 in regular trading after crude inventories fell -6.3 million barrels over the last week. This was far more than the expectations for a decline of one million barrels. Refinery utilization spiked higher to 88.4% from 86.4%.
Crude imports declined by a whopping -549,000 bpd or 3.8 million barrels for the week. That is the equivalent of two VLCC tankers. This could be the result of timing issues where a tanker arrived early the prior week to cause the unexpected rise of +3 million barrels and possibly another tanker delayed by weather that will be shown in the current week's numbers. We really can't draw too many conclusions about a single week of dramatic inventory changes. It is the longer term trend we want to watch. I would expect inventories to rise next week.
The spike in refinery utilization by +2% helped to increase the demand for crude oil by +433,000 bpd. The surge in refinery demand and the sharp drop in imports combined to produce the large decline in inventories.
Gasoline inventories declined by -400,000 barrels. That is also unusual since inventories are normally rising this time of year. There was a decline in imports of -198,000 bpd. Gasoline production increased by +332,000 bpd thanks to the surge in refinery utilization. Gasoline inventories are now +7.5% over year ago levels.
Those refineries must have been processing a lot of heavy crude because distillate inventories jumped +2.6 million barrels and the second consecutive week of large increases. Distillate demand declined by -65,000 bpd and imports and production were basically flat.
(Inventory Snapshot guide: Green squares are multiyear highs. Yellow is multiyear low. Orange is multi month high. Pink is multi-week highs. The number of active gas rigs at 350 is an 18 year low. Oil rigs at 1,412 is an eight-month high. Crude oil at 397.6 mb is the highest since 1931.)
Crude Oil Inventory Chart
Gasoline Inventory Chart
Distillate Inventory Chart
We are in the first week of hurricane season and the first tropical storm has formed in the Gulf of Mexico. Andrea currently has winds of 40 mph and is moving slowly north at 3 mph. The storm is not expected to increase in intensity enough to be a serious problem for the oil patch and starting Thursday the track is expected to move northeast away from the fields.
Longer term it is expected to move up the east coast and cause storm surges and high winds all the way to New York. Residents still recovering from Sandy are going to be very cautious about a second storm this soon. No word yet on whether it will strengthen after passing over Florida. It could also evaporate into a disorganized pattern of storms and rain.
The U.S. markets are at a rebound point. The selloff has reached the level where dip buyers should appear. This does not guarantee a rebound but it should produce at least a bounce.
I would watch for another pattern of lower highs as the bounce loses traction. At this time I believe we will see lower lows later this summer.
We are going to be heading into the summer doldrums where traders are absent from the market and spending time with their families. Be patient because we will use any declines as a buying opportunity.
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