Mixed Economics Push Dollar Lower

Jim Brown
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Worries over what the Fed might do when it meets next week and conflicting economics from around the world pushed the dollar lower commodities higher.

The taper talk is alive and well and uncertainty is building in the U.S. over what the FOMC will do about QE when it meets next week. This is a tempest in a teapot for multiple reasons. Inflation at 1.1% in the last report is at a 50 year low and falling. New jobs have not been over 200,000 in three months and FOMC members say they want to see "several months" over 200,000 before making any QE changes. The U.S. manufacturing sector is in contraction. The sequestration is going to knock 1.5 points off the GDP for Q2 and Q3. Home sales are slowing because of rising prices and rising interest rates.

The Fed is not going to rock the economic boat when it is already on the verge of capsizing. They have tried for four years to push the economy into a self sustaining recovery and it is far from self sustaining. The last Beige Book downgraded the pace of recovery from "moderate" to "modest to moderate" pace. Officials said impacts from sequestration were weighing on the Midwest, South and West and signs of weakness were growing. Global economic weakness was weighing on the Northeast and West. It was not a particularly upbeat report.

The daily taper chatter is just noise. Investors need to tune it out until the post meeting announcement.

Supporting oil prices and pressuring the dollar was news eurozone industrial production rose +0.4% in April. Analysts and the official statistics agency, Eurostat, expected flat production after the +0.9% gain in March. This was positive for the euro.

Germany's harmonized inflation rate rose less than expected at +1.6% in May compared to +1.1% in April. Flash estimates were for a gain of +1.7%.

Unemployment declined by -8,500 in the U.K. in May. Expectations were for a decline of -5,000.

These are not earthshaking improvements in European economics but they are improving. That lifted the Euro and depressed the dollar.

On the flip side Japan's core machine orders fell -8.8% for April. That was worse than the -8.1% expected. On the year over year basis they rose +1.1% and beating expectations for a -4.3% decline.

The Japanese Nikkei declined again with a -28 point loss but it closed at the highs for the day and +300 points off the lows. Resistance is 13,500 and support 13,000. The Nikkei has been a direct influence on the U.S. markets over the last month because of the sudden correction in the middle of an aggressive QE program.

Nikkei Chart

Dollar Index Chart

Crude oil rose slightly for the day despite a build in inventories of +2.5 million barrels. Analysts expected a -1.5 million decline. I believe this was a simple bookkeeping adjustment after inventories reportedly decline -6.3 million barrels in the prior week. I think there were some timing issues on deliveries and they caught up last week. To confirm this there was a huge spike in imports of +582,000 bpd or more than 4 million barrels. Also aiding the inventory gain was a decline in refinery demand of -225,000 bpd. I am surprised the inventory gain was not stronger.

U.S. production fell by -72,000 bpd to the lowest level in two months at 7.224 mbpd. The decline in U.S. production allowed inventories at Cushing to decline by -700,000 barrels to 49.3 million. That is the first time in four weeks that inventories were less than 50 million barrels. As more shale oil is transported by rail to the coastal refineries the pressure on Cushing will ease. However, production is still expected to rise another 600,000 bpd by year end but that will be offset by new pipeline capacity to deliver Cushing oil to the Gulf of Mexico refineries.

Gasoline inventories rose by +2.7 million barrels and the highest level since April 12th. Demand fell by -174,000 bpd and imports increased by +178,000 bpd. Gasoline inventories typically build from now until late September when the driving season ends and refineries halt production to switch back to winter fuel blends. Inventories are now almost 10% over the year ago levels.

Distillate inventories declined by -1.2 million barrels thanks to an increase in demand of 327,000 bpd. Imports declined -91,000 bpd and production declined -121,000 bpd. Refinery utilization declined from 88.4% to 87.5%.

Refiners are sensitive to the rebound in crude prices and falling gasoline prices. This reduces the crack spread and they are in no hurry to over produce gasoline and diesel and drive prices lower. They are going to manage their inventories in hopes crude prices decline.

The number of people unemployed and the high cost of gasoline has caused a sharp slowdown in overall demand. Vacations are being eliminated or cut short. Destinations closer to home are the rule. State parks well away from population centers are reporting a drop in attendance. Airlines are continuing to cut back on capacity and fewer planes/routes means less fuel burned.

All of these factors are reducing overall fuel demand. Petroleum product demand has declined to less than 18.0 mbpd despite this being the summer driving season. Total refined products supplied last week were 17,923 million barrels per day. The same week a year ago saw 19,405 mbpd supplied to the market. That is a decline of 1.482 mbpd from year ago levels.

This drop in fuels was strong with jet fuel falling from 1.645 mbpd to 1.235 mbpd. Gasoline declined from 9.130 mbpd to 8.648 mbpd. Diesel increased from 3,685 mbpd to 4.078 mbpd.

Personally, I believe the sharp decline in refined product demand suggests we are slipping back into a new recession. Product demand is a direct result of economic activity and clearly that activity is declining.

(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.)

Inventory Snapshot

Crude Oil Inventory Chart

Gasoline Inventory Chart

Distillate Inventory Chart

The weak economic conditions in Europe and the USA have caused overall fuel use to decline below that of the west of the world for the first time ever. The OECD members (34 developed countries) used 44.3 mbpd of liquid fuel in April according to the EIA. Non-OECD (emerging economies) consumed 44.5 mbpd. The EIA expects that to reverse in the second half of the year because of increased consumption in the USA. Unfortunately we are not seeing that in the data. As recently as 2005 the OECD countries consumed more than 60% of global fuel supplies. Since 2005 the OECD consumption has declined -9% while non-OECD consumption has risen +28%. The increased demand came mainly from China, India, Saudi Arabia and Brazil.

OECD fuel growth is expected to rise +1.1% in 2013 and +2.4% in 2014. Non-OECD consumption is expected to rise +4.2% in 2013 and +5.0% in 2014.

In the USA total liquid fuel consumption has fallen for the sixth time in the last seven years due to the recession, high unemployment and high fuel prices.

The IEA released their June forecast and predicted the demand for OPEC crude would decline to 29.8 mbpd in the second half of 2013. That was -200,000 bpd lower than the May forecast. According to the IEA the OPEC nations produced 30.9 mbpd in May compared with their quota of 30.0 mbpd. The IEA said OPEC needed to cut production by -1.1 mbpd in order to keep prices stable at a rate that aggressive exploration would continue.

The IEA warned that signs from China suggest the economy is weakening. With Brent crude trading at $103.50 today and only slightly above the threshold price of $100 that OPEC has pledged to support the cutbacks need to appear soon.

The IEA said oil demand in 2013 would increase by 785,000 bpd to 90.6 mbpd. OPEC released its estimates on Tuesday for demand growth to rise +780,000 bpd to 89.7 mbpd. The slow growth was a result of sluggish economic conditions in the OECD nations. The IEA expects China to account for +365,000 bpd of that increase to total 9.96 mbpd of Chinese consumption by year end. That is 15,000 bpd lower than the May forecast.

Saudi Arabia has increased production by +220,000 bpd to 9.56 mbpd with the extra oil being used to produce electricity in Saudi Arabia during the hot summer.

The IEA said non-OPEC production would grow to 54.5 mbpd by year end, an increase of 1.1 mbpd.

The IEA said global inventories increased by 16.7 billion barrels in April to 2.68 billion. They said that was a "marginal" surplus compared to the five year average.


Market sentiment has changed. After six months in rally mode it appears the uncertainty has weakened buyers enthusiasm for equities. Japan is melting down despite a super aggressive QE program that invests in bonds, REITs and ETFS. Yes, markets can go down even when the central bank is supplying liquidity with a fire hose. This sudden realization by investors has made them a little more cautious about buying the dips.

Couple that with the uncertainty over the continuation of QE at the present rate and suddenly there are more sellers than buyers. We are also approaching the warning cycle for Q2. The Q1 earnings cycle had a lot of negative guidance for Q2 so we should not see a lot of warnings. However, a few random companies have already confessed so worries are increasing that Q2 earnings could disappoint.

Weak economics in the U.S., a potentially weak earnings cycle, uncertainty over next week's FOMC meeting after six months with no correction and the market is ripe for a significant dip.

The S&P declined to the 50-day average at 1611 again on Wednesday. This time there were no dip buyers. The first dip last week was strictly a technical bounce followed by a short squeeze. The dip today had many excuses but no main reason other than profit taking. When the market wants to go down it will find an excuse. Today it had plenty.

The S&P futures are down -8 at 10:30 Wednesday night. That is 1,601 on the futures and if that holds overnight would put the S&P back at round number support of 1,600.

S&P-500 Chart

Energy stocks have lagged the market decline because oil prices have been firm. That could change in a heartbeat if support at 1,600 breaks. Sometimes you have to sell what you can rather than what you want to sell. It is easier to take profits on winners than sell losing positions. We become emotionally attached to positions and tend to make bad decisions in a down market.

We are heading into the summer doldrums where traders are absent from the market and spending time with their families. Be patient and we will use any declines as a buying opportunity.

Jim Brown

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