Inventory Taper

Jim Brown
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The Fed may have decided not to taper QE but there was a huge taper in oil inventories. The combination of inventory declines, dollar drops and the prospect of no QE taper this year sent oil and gold soaring.

The morning started off good for oil prices with a -4.4 million barrel drop in crude inventories. That is the largest decline in months and pushed the inventory levels back to August of 2012. This caused a decent short squeeze but it really caught fire after the FOMC announcement.

The Fed surprised everyone by not tapering QE and suggesting in the comments and the Bernanke press conference that a QE taper was "possible" by year end but the tone was "not likely." The Fed downgraded their economic expectations for the rest of 2013 and for 2014. Bernanke said the economic outlook had diminished from the start of the taper talk and they would continue QE on a "data dependent" basis. Since they downgraded economic expectations it would take a dramatic improvement in the economy to put the Fed back on a taper course.

The Fed shocked everyone because their three months of talking taper had been factored into the markets and they could have easily cut their purchases by $10-$15 billion and nobody would have cared. The fact they did not take the "free" taper cut suggests the Fed thinks the economy is actually worse off than they are telling us. The Fed is always optimistic and that assumes their lowered expectations are still optimistic and reality will be lower.

The Fed decision crushed the dollar due to the comments that suggested QE would continue for some time. The dollar index fell to a nine-month low.

Gold rallied +$53 to $1361 or a +4% gain. Silver rallied +6.1% to nearly $23. These were primarily short squeezes since nearly everyone thought the Fed would cut QE and the dollar would spike higher. This is a game changer for the metals and for gold the $1300 level should now be support and with the debt and budget battles heating up in Washington we could see a return to $1400.

Crude prices rallied sharply in the morning on the inventory drop and again in the afternoon on the dollar drop. The nearly $3 gain erased the losses for the prior two days.

Crude inventories fell -4.4 million barrels to 355.6 million. This was largely due to a sharp drop in imports of -439,000 bpd or more than 3.0 million barrels for the week. At the same time refinery demand for crude rose +214,000 bpd or another 1.4 million barrels. Refinery utilization remained unexpectedly high at 92.5% and very uncharacteristic for this time of year.

Despite the abnormally high refinery utilization the gasoline inventories also declined by -1.6 million barrels. Gasoline demand rose 423,000 bpd and production increased +219,000 bpd. This has to be leftover retailer restocking from the Labor Day weekend draw downs. There is nothing in the economy to support this surge in demand.

Distillate inventories declined -1.1 million barrels due to another abnormal surge in demand of 528,000 bpd. Like gasoline there is nothing in the economy to cause this much of a spike in demand. It has to be inventory shuffling from refiners to retailers.

Cushing inventories fell for the 9th consecutive week to 33.5 million barrels as producers ship increasing amounts of crude direct to the refiners by rail. This has got to be a real change of operations for Cushing after setting a record high at 51 million barrels earlier this year. Inventories have declined -40% just as new storage capacity was coming online at the facility. Several pipeline companies have just completed several million barrels of new storage and now there is nothing to put into the tanks.

There is another possibility on the drop in crude draw downs. You may remember over the last couple weeks there were several major storms and one hurricane east of the Gulf of Mexico. When those storms appear the tanker drivers throttle back on their speed and stay behind the storms as they move west. If the storm is going to cross their path they will steer away from it. All of these maneuvers add days to weeks to their transit time. With imports falling -3.0 million barrels for the week that could simply be a 4-5 day delay in arrivals due to the storm delays. Those delays push the deliveries and inventory additions into a different week.

At any given time there are a constant number of tankers in route to the USA. This is a constant stream. The oil was purchased months before and most on long term contracts so the supply is constant. A major storm in the Atlantic disrupts this stream but it does not stop it. Those ships will simply arrive late and there will be a corresponding bump in inventories when they arrive.


All the major indexes broke out to new highs on the FOMC decision. All are now in blue sky territory and in a normal market we would be looking at a continued surge in gains as traders cover shorts and investors chase prices. Unfortunately this is not a normal month.

Now that Syria is behind us the headlines are heating up on the debt ceiling debate and the budget battle. The House is expected to pass a continuing resolution this week that locks in the spending cuts from the sequestration and defunds Obamacare for 2014. Obviously this will be DOA in the Senate so the headline battle and "government shutdown" headlines will be plentiful. This is going to drag on the market and could cause some serious volatility.

The good news is that it will eventually be resolved and the markets are poised to rally into yearend once that occurs. I would be cautious about adding new long positions until we are past the budget war.

Jim Brown

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