Month End Selling

Jim Brown
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The Dow and S&P lost all of their intraday gains as heavy selling appeared at the close. This is typical for the last day of the month where funds even up their accounts and adjust portfolios. The first day of the month is typically bullish with new retirement contributions being put to work.

The markets dodged several bullets today with the economic reports and FOMC announcement all market friendly.

The Q2-GDP report said the economy grew at a stronger than expected pace of +1.67%. Q1 GDP was revised down from +1.78% to +1.15%. The GDP report was calculated using the new rules devised by the BEA so today's number really does not relate to the estimates for 0.4% to 1.1% growth. It would be comparing apples to oranges. Whenever the government wants to show higher numbers in some report they change the calculation to include or put more weight on the metrics they want to boost the scores.

Traders, unaware of the changes to the calculation simply saw a better than expected number and were blissfully ignorant of the details.

The ADP Employment report showed private payrolls increased by +200,000 in July compared to estimates of +180,000. The June number was revised up by +10,000 to +198,000. The private sector appears to have weathered the storm caused by the sequester and did not collapse as Obama had predicted. The postponement of Obamacare for corporations for another year also freed up the hiring process. Companies are more open to hire again knowing they will not have to provide healthcare or pay fines until 2015.

The FOMC statement was actually more dovish than the one in June. They added language to discuss falling inflation but still kept their guidance that it should rise later in the year. The said nothing about QE tapering and kept the language for the third month saying they remain open to either raising or lowering QE purchases based on future economic data.

The inflation worry and the added emphasis must have appeared James Bullard because he dropped his dissent to current policy. Esther George dissented again on the grounds of the unknown cost of QE and the risk or economic and financial imbalances.

The statement also mentioned the rise in mortgage rates. That has caused home sales to drop sharply and by mentioning it in the statement that is a clue the Fed is not going to act and push rates higher unless it has to. That means QE is probably farther out in the future than September.

The FOMC statement caused a short blip higher in the market but sellers appeared shortly thereafter to push the indexes back to their lows. There are always a lot of program trades after the statement. Funds want to take advantage of the increased volume to sell stocks. Retail traders buy the announcement and institutions normally sell the announcement.

Oil prices rallied on the better than expected economic news and the EIA inventories. For the first time in five weeks crude inventories did not decline. In the prior four weeks crude inventories declined -29.9 million barrels and the biggest drop since 1982. Cushing inventories fell -1.9 million barrels to 42.1 million. Cushing inventories have declined -7.3 million barrels in July and the most in nine years.

The sharp decline in crude levels along with the conflicts in the Middle East and Northern Africa have combined to push crude to 14-month highs. Crude prices had been declining over the last week but the GDP and ADP numbers caused a bout of short covering on expectations for stronger demand. At least that is what the analysts claim. Any increase in demand is not showing up in the weekly numbers so relying on GDP for a past quarter as justification for rising demand does not cut it for me. The weekly inventory numbers are far more accurate as a forecasting tool.

Libya closed all export terminals except for Zawiya due to labor protests arising out of the general unrest in the country. The closure will reduce Libyan exports from 1.425 mbpd to 325,000 bpd. This was more than likely the reason for the spike in crude prices today.

In the chart below the gasoline demand is following closely with the 2011-2012 demand patterns. After a demand dip in May it returned to the normal level and should decline again when driving season is over at the end of August.

Gasoline Demand Chart

Crude inventories rose by 400,000 barrels to 364.6 million. Analysts were expecting a -2.8 million barrel decline. Crude imports rose by +136,000 bpd to 8.17 mbpd and a six-week high.

Crude imports fell -13.2% to hit an 18-year low in May to 7.737 mbpd according to data released by the EIA today.

Gasoline inventories rose by 800,000 barrels to 223.5 million. Imports rose by +378,000 bpd to 700,000 bpd. Production rose by +289,000 bpd and demand rose by +165,000 bpd.

Distillate inventories declined -500,000 barrels and less than half the -1.2 million barrel decline the prior week. Distillate demand declined by -332,000 bpd and production fell by -171,000 bpd.

(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 inventory Chart

Gasoline Inventory Chart

Distillate Inventory Chart

Tropical storm Dorian evaporated and there are no storms on the radar for the next 7-10 days.

BP said it was not likely to settle with the U.S. government over the Deepwater Horizon spill because expenses were rising too quickly. BP had previously set aside $42.4 billion for the expected cost of the spill. The company still faces up to $17 billion in fines over the oil spilled into the Gulf. The company has completed sales of $38 billion in assets to raise cash to pay for the costs.

BP agreed in 2012 to pay $7.8 billion to thousands of individual claimants. The agreement was turned over to an administrator to handle the payments. Almost immediately BP began to object because the administrator was not following the procedures BP had agreed to. They went to court to stop the payments and the judge refused to temporarily halt payments while a trial proceeded. BP said the cost of that portion is now up to $9.6 billion and growing due to fraud and corruption in the payment process. Basically anyone can file a claim with little or no documentation and receive a check.

BP reported Q2 earnings of $2.7 billion that missed the consensus estimates of $3.4 billion. Lower oil prices, currency exchange rates and rising expenses related to the Gulf spill were the cause. They also suffered from an enormous tax rate of 45% in Q2. BP produced an average of 3.2 mboepd and they said output would be lower in Q3 because of asset sales and maintenance issues. That will knock -150,000 bpd off BP's total production.

BP shares lost $2 after the earnings news.

BP Chart

Natural gas fell to a five month low after lower than normal temperatures suggest inventories will grow significantly. Gas futures fell to $3.45 after forecasters predicted mild weather across the Midwest, North Central and East Coast. Gas in storage has already increased +19% since the beginning of June. When tropical storm Dorian evaporated the worries over Gulf production outages also evaporated.

Shanghai China is not so lucky. They are having a flurry of heat stroke deaths after temperatures moved over 100 for nine consecutive days. It has been the hottest Shanghai summer in 140 years.

Natural Gas Chart

The House is expected to pass new legislation this week that will eliminate the rest of Iran's crude oil exports. These are the toughest sanctions yet but it won't be seen by the Senate until September because of the August recess. The new legislation will strongly coerce existing buyers of Iranian oil to shop elsewhere.

Iran's new president, a moderate cleric, has made improving relations with the U.S. a top priority. As a gesture of good will the U.S. eased restrictions on sales of medical devices to Iran after the new president, Hassan Rouhani. requested direct talks with the U.S. over the nuclear sanctions.

In Iraq Al Qaeda said the attack on Abu Ghraib prison on July 21st was a significant victory for the extremist group. More than 500 prisoners were freed. The group announced its "Breaking the Walls" campaign in July 2012. The goal of the campaign was to free prisoners across Iraq and regain lost territory. The 12 month campaign has seen 20 waves of simultaneous vehicle bourne explosive attacks, eight major prison attacks and the occupation of territory formerly free of Al Qaeda. Each VBIED wave consisted of eight or more explosions in one day. In the spring of 2013 these waves occurred as frequently as twice a week. Total civilian causalities in July are already the highest for any month since May 2008.

Civilization inside Iraq is breaking down and oil exports are slowing rather than increasing as the government expected when it awarded contract to major oil companies two years ago. I would not expect Iraq to meet its goals of 7.0 mbpd by 2020. They will be lucky to hit 4.5 mbpd.

At the same time Iraq is mounting an effort to promote tourism. Iraq has numerous sites and shrines previously frequented by tourists but they are notably absent after the breakdown in civil order. Let's all go to Iraq and play "find the IED."

Portfolio Update

Be sure to check the changes in the current play section. As planned we exited eight positions this week in anticipation of a decline over the next several months.


There are two big reports left this week. The ISM Manufacturing on Thursday and the Nonfarm Payrolls on Friday. After that the majority of earnings will be over and the next couple of weeks are devoid of any major economic reports. The markets will be left to focus on fundamentals and those have been sorely lacking.

Nobody knows if this year will follow the seasonal patterns for an August decline but I would want to err on the side of caution rather than load up with long positions on the first dip.

Crude prices typically decline in August-September and then rebound in the fall as winter heating oil demand increases. Investors should wait for the normal end of summer weakness to add long positions.

Jim Brown

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