Crash Or Correction? SocGen Answers

Tyler Durden's picture

Following last week's crude drubbing brought about by correlations gone wild, following the 5 sequential margin hike-inspired collapse in silver, many are wondering if the silver correction is over, or if the crash is just starting. Here is Soc Gen joining in a very schizophrenic Goldman (a month ago: sell; yesterday: buy) telling clients the coast may be clear now that all the weakest hands have been purged (following SLV 88% share turnover on Thursday any latent mania elements have been exorcised).

From SocGen:

Oil prices experienced a huge sell-off this week, plunging by $12 /b on Thursday (11% over the week). Other energy prices followed but the extent of the move was much less limited (between –0.6% and -3.5% over the week). This can be explained by a number of reasons – most of all it seems market participants were finally convinced by the economic newsflow that downside risk have become dominant and it was time to take profit. The question now is obviously if - after the usual technical rebound - this will continue next week and translate into a crash, energy markets in Europe following oil with a lag. Or if prices will stabilize close to present levels, in what should then be considered as the correction of excesses. Our view is that the correction, a violent one, could be over as overall fundamentals remain sound. Hence some prices will stabilize (coal and power), at least temporarily. Further drop for gas is however expected, coming from the continuing seasonal adjustment for which gas is late as compared to the other components of the power complex. Carbon should suffer from this gas movement, with limited downside risk.

Full note:

Energy prices collapsed this week. Brent month ahead contract dropped by a staggering 11%, moving from $125.89 /b to 112 /b, of which almost $12 /b in a single session (Thursday), a rare fact. Following this dynamics but with a much lower amplitude, gas prices (NBP month ahead) lost £p2 /th and closed on Friday at £p55.8 /th (-3.5%). For coal, power and carbon prices, the pattern was slightly different. They started the week with an increase. German baseload Cal12 and CIF ARA Cal12 reached €59.82 /MWh and $133.25 /t respectively on Monday and Tuesday, continuing on previous week’s momentum. Then they followed the oil prices and strongly retraced from Wednesday to Friday. On the whole, German baseload Cal12 and CIF ARA Cal12 lost €0.9 /MWh and $3.75 /t, closing today at €58.2 /MWh and $129 /t. For carbon, the early week increase was strong with Dec11 EUA closing on a  new high €17.42 /t on Monday, at a level not seen since November 2008. The contract fell only by 0.6% over the week and finished
today at €17.04 /t.

So the energy markets brutally turned eventually. This comes after two quiet weeks marked by long breaks and holidays across Europe, delaying decisions – which might partly explain the brutality. Last week had finished on a rather bullish note, encouraging our view for this week that prices would still hold to high levels, and even increase for some of them (coal in particular). Fundamentals indeed had turned more supportive for prices, but sentiment made it all in the last four days.

What happened? The market had become nervous over the recent weeks on concerns that the emerging countries would see their growth reduced in H211 due to the difficult fight against inflation, which is leading some of them to tighten their monetary policy. China has been in a tightening cycle for months – without much success on inflation readings so far. When India surprised this week by raising interest rates by 50 bps instead of the expected 25 bps, the concerns heightened. As the most liquid commodities (oil, precious metals) have largely become a macroeconomic play, and an EM play in particular, these concerns had lead investors to consider commodities as increasingly risky assets, whose potential for appreciation had turned quite limited in the short run. The good Q1 corporate results in the US and in Europe, very often beating analysts’ expectations, had temporarily appeased these fears  as they sent equity indices up to levels unseen since mid-2008 (for the US stocks at least). The enthusiasm over, operators have  started to take into consideration the bad news again. And realized the dark cloud has been getting darker and bigger over the recent weeks.

Western economies remain fragile. In Europe the lingering risk of the sovereign debt crisis is in the news again, through the Portugal bailout and the talks of Greek debt restructuring. In the US, the debt rating downgrade is still in the memories and the end of QE2 in  June leaves the market wonder if this means the end of ever more cheap liquidity around, hence the end of the golden period for risky assets. The rising topic of oil demand destruction due to high prices, the bad unemployment figures yesterday in the US (jobless claims increased to an 8-month high while they were widely expected to drop) and the bad German factory order figures exacerbated the worries on the state of the developed economies.

At the same time the threat of inflation is also getting more precise in the US and Europe, which eventually is no good for growth either, as it will lead to rate hikes. For oil, the bearish inventory report mid-week (see our US Petroleum Report dated 4 May) showing unusual stock builds even as the Driving Season is coming near, combined to news OPEC was considering raising formal output limits when it meets in June, pushed in the same direction.

Much has been made about the impact of Bin Laden’s death. While it might reduce terrorist risk, it is not completely clear why this would lead to lower risk of oil cuts in the Middle East – for this, the less commented demise of one of the Libyan leader’s son over  the same week-end could actually bear more impact. The big “Abbottabad news” was for us used more as a pretext to the first profit-taking, which was actually short-lived on Monday. But the date will for sure be remembered as the turning point for the oil market, even if the real fall in oil actually trailed losses in precious metals later in the week. The bearish reaction was compounded by the ECB’s press conference yesterday, during which Mr. Trichet dampened the expectations for a rate hike in June. This sent the Euro rapidly down, EUR/USD retracing from 1.48 (up to now seen as a pause before 1.50) to 1.45, which is also bearish commodities.

It is to be noted however that the astounding drop in oil prices fails to be reflected into other energy commodities, which fell only by 2% to 5% so far. This for us stems from two main reasons: barring oil, energy commodities are little invested by non-commercial players, whose behavior is evidently fuelling the movement for oil; and the stronger fundamentals for thermal coal or power in  Europe also helped limit the downside compared to oil.

Seen in retrospect – as usual – we can see the energy prices had to go down! What was doubtful before becomes so clear afterwards… Hence, the real interesting question for next week is: will prices stabilize and rebound, or continue falling? Was this a  correction, or is this the beginning of a crash, the explosion of a “bubble” that will take off the classic 30% off the (oil) prices? In each case, which levels will the prices reach?

Our view as a team was that a correction was to be expected but that Brent prices should for now remain in the $110 /b - $125 /b range. See for instance our Commodity Strategy - Brent 1x2 Put Spread at zero cost to benefit from tactical correction dated 4  May, where the following paragraph appears: “In conclusion, there seem several reasons to expect a correction lower in Brent prices over coming weeks. The key question is then how deep and long lasting such a correction is likely to be? We believe that any correction is unlikely to drop below $110 and any drop below $115 is likely to be short-lived.” We also think that solid fundamentals do not warrant a full-fledged crash (the -30% guy who would take oil back down to $85 /b), and that energy prices had not reached a “bubble-like” level. Hence the room for downside exists but is not massive. Economic fundamental first, are not that bad. H211 will  be weaker, which is what the market is rapidly pricing now. However according to SG Economic team central scenario the theme of double-dip is behind us and the economies are recovering for good.

More precisely, on the energy commodities we follow two views are possible. Either the more inert, less investor-driven coal, gas,  carbon and power markets will more heavily come down next week, after a 2-day lag. Or they are close to finishing their correction, even if it can seem limited. In this case they would stabilize next week. Actually our view is that they have probably finished the part in their consolidation that corresponds to the unavoidable sympathy with oil prices. But that they have not finished their seasonal adjustment, at various levels. Hence some of them will stabilize next week (maybe temporarily as there is still some time for the season to play before summer), while other will continue coming down due to a higher gap with what seasonal conditions would justify.

For coal, prices are undergoing the spring adjustment we have been expecting, but could be supported in the short run by continuing Chinese buying. Low inventories and Chinese domestic prices come closer to international ones are the main reasons behind this resurgence. For gas on the contrary, the market (wrongly we argued in our 19 April European Gas Special: five reasons for NBP gas price to go down this summer) thought lots of LNG would be diverted from UK to Japan to make up lost nuclear supplies but on Thursday the UK was in fact receiving more LNG than could fit in the pipelines at MilfordHaven, home of SouthHook and Dragon LNG. Dragon and South Hook were together flowing over 70 mcm /day into the national transmission system, about the maximum combined flowrate that has been seen in recent months. The high LNG supplies should continue to compensate for any other problems that could arise in Norway. Please refer to our equity Statoil note explaining that Statoil production in Q1 11 has been lower than Q1 10 and that Q2 and Q3 11e should also be below 2010 levels. We remain bearish for next week, especially in light of the rising temperatures. For carbon, our view is that the drift of gas prices lower will weigh downward, and that prices could suffer a bit. However there is little in the present price dynamics that could herald a significant departure from the €17 /t – its new average. For power, we think that coal prices are still price-makers in the German system, so that power prices will be relatively supported. However we think that NewC will be more resilient than CIF ARA (see our Thermal Coal trading idea dated 5 May Long NewC /Short CIF ARA) so we see risks more biased to the downside.

Overall, we expect coal (CIF ARA Cal12) and German baseload Cal12 to remain above $128 /t and €57.7 /MWh. On the contrary, gas (NBP month ahead) should continue its consolidation to £p54 /th. Finally, carbon should to be traded in a range €16.7 /t - €17.2 /t. Given this configuration and without strong downward move of the EUR/USD, German dark spread should remain stable while German spark spread will continue increasing (see our European Gas and Power Strategy dated 3 May Long German Spark Spread). We anticipate slight steepening of the CIF ARA forward curve with Next Quarter – Next Year spread decreasing to $-4 /t. For the NBP forward curve, the seasonal adjustment will weigh on the shortterm maturity contract and timespread will accentuate their drop.

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Captain Benny's picture

Equities have yet to "correct" ... If they did, I think we'd be closer to that remarkable  S&P 666 low...  hmm.  We also haven't seen the big muni defaults expected over the next two years... those should start by mid-summer.

Back to the PMs: Someone should tell the CME that they cannot create physical by increasing margins.  The big physical squeeze is on and it will only accelerate through the summer.

dick cheneys ghost's picture

M. Whitney has recenty said she is more confident than ever about her call. If one is following the news at the local level (states and cities) would have to agree with her........the states and cities are absolutly f*^cked. 

PY-129-20's picture

Your blog is great, dcg. Keep up the good work.

Muir's picture

"We also haven't seen the big muni defaults expected over the next two years... those should start by mid-summer.'


Weisbrot's picture

I wonder if any of the states still have any of the tarp they were foreced to eat... also, I wonder how many quiet back door bail outs are or have been negotiated.  all that out of the way I still go with Merideths call & research. (even if it takes a few months longer to play out)

Madcow's picture

Yes - deflationary.  In a deflation, the senior currency - gold - strengthens.

T-NUTZ's picture

so equities are going to correct, muni's are going to default, and PM's are going to soar?? This is butt logic.   some of you guys are going to be schooled by a viscious bear market rally in Uncle Buck.

cosmictrainwreck's picture

yep - am considering x% in UUP just because everybody knows USD is trash

drom's picture

Really do you see China and and India changing their minds and start to save in paper USD over gold and silver all of a sudden.  Get real man the golbal shift is going toward PMs not away, its not like any one of our fiscal problems have been recently solved. 

If you expect the next bear maket to look exactly like the last one we saw here is how you could be easliy wrong: The market now understands that another recession means more QE (and possibly more stimulus).  The markets smart enough to put those two together.  So while we might get a deflationary head fake, no way Mr Bernank will allow deflation to actually happen, he also strongly believes the depression occured due to tightening to quickly.  With this said its easy to imagine PMs going up in the next downturn as we all know Bernanke will not just watch, but if the market sells them off again, well I will buy them again, then when Bernank announces there will be an unknown amount of QE after June then they will prop right back up.

T-NUTZ's picture

you do not understand the function that cash plays in panics.  when people get their asses handed to them Sept 2008 style, they do not look for a new "investment" to put their cash into.  They sit in cash and lick their wounds and wait for the smoke to clear.  I for one traded through that hell hole and it's too bad that some people's memories are short.  PM's will be trashed with stocks.

mamba-mamba's picture

To me, FWIW, it makes sense that in a recession (with price deflation) cash is king. The catch is Bernanke. He absolutely will not let it happen. He can't. He can't allow shrinking GDP (in nominal terms) because it leads to austerity and/or default. He will print. He will do anything and everything in his power to prevent a deflationary collapse. This is why I remain bullish on PM's. Basically I am in oil, natural gas and paper PM's. I also have about 50% of my "investment money" in cash, just in case we do have a deflationary collapse. I'm not trying to get rich. I'm just trying to position myself for financial survival.

I'm also trying to buy a rural property right now. Then I will probably sell my house in the city. I don't actually have a lot of money to invest. So maybe you shouldn't listen to me anyway. ;-)


By the way, I wouldn't touch US stocks or treasuries with a 10-foot pole right now. I have a small short position on treasuries. And a small long (pre-tsunami) position on the Nikkei.

Weisbrot's picture

if ponzi can not pay his silver today - then force majure is on the way.

FOC 1183's picture

"our view as a team" = danger will Robinson, danger; and 9 times out of 10, 1x2 put spreads = might as well write a check to charity.

falak pema's picture

twin fork to the edge of the world : what happens when the QE stops momentarily as of July 1. It gives the speculators the jitters. Deflation runaway or will the inflationary dyke hold fed on commodities? The world holds its breath all the while the currency war rages on...

Auricle of Omaha's picture

I don't often speculate, but when I do, I prefer physical silver and gold... Bitchez

jaffi's picture

"what happens when the QE stops..."

I personally expect a fall in equities, a move to liquidity, a fall in commodities, and rising treasury yields.  Yes, I know that a rising dollar and increasing yields seems counterintuitive, but we all know current rates are insane, that market rates should be much higher, etc.  The fact is that many other currencies are beginning to rise and there is not enough buyers for treasuries right now to fill up the gap, so yields must rise even if the dollar gets a little strength; though, I wouldn't expect the dollar index to rise quite so dramatically (maybe low 80s).  But, I see this all as short-term noise, as the Fed will have no choice but to implement QE3 in order to facilitate coupon payments from the treasury, as well as institutional recapitalization.  After that, the presses will hum, and we'll be right back to a commodity bull market.  

Basically, I expect a short, but rapid consolidation across the board (as well as some corrections), and then right back to the trend.

I agree with speedy to BTFD, but it depends on which dip you're talking; definitely take advantage of the short-lived rally in the dollar.  Commodities-yes (PMs-most certainly).  Equities-maybe (depends on the stock).  Treasuries-not until QE3 is ready to roll.  Dollars-makes sense, just so long as you get out of liquidity in time.  Personally, I am buy and hold on commodities, and play the exchanges on currencies and equities.  In either case, we'll definitely find out, won't we?

speedy's picture

I think I will BTFD.


AG BCN's picture

I did, pulled the trigger on some Libertado's this afternoon. If I am wrong then I am wrong and so be it.

achmachat's picture

I did twice yesterday. Once in the morning, then, when I wanted to get more, my usual "dealer" was dry so I found another one and ordered a test batch of 100 Philharmonics.

AG BCN's picture

good man, we will rise or fall together.

takeaction's picture

Just bought another 300 Buffalos on Ebay.  If you use the new IE9 promotion you get 10% back in Ebay if you pay attention you can get close to spot with this discount until May 18th.

speedy's picture

WTF? Junked for BTFD!


Silver Bitchez!

Tuco Benedicto Pacifico Juan Maria Ramirez's picture

Please increase your current vocabulary by one word and replace one of the two words in your current lexicon.  (The one which starts with a "b".)  Listening to a man use the b word is like seeing a tatooed lady.


Tuco Benedicto Pacifico Juan Maria Ramirez

el-greco's picture

Sorry, but i think this report is utter rubbish. I hope nobody is paying for it and i'm glad i dont bank with these guys.

CrashisOptimistic's picture

It's not utter rubbish.  It's flawed.

Rule #1.  FORGET EQUITIES.  They reflect nothing more than cash on the books borrowed hand over fist by CFOs whose lifetime of training told them to borrow big when rates are low.  Earnings derive from taking bad loans off the books of the banks, and that imaginary money buys products.  So just forget them.  

Rule #2.  Only Oil Matters.  Sorry PM guys, you are not vital to the food supply.  Only oil is.

Rule #3.  Stop lumping Oil with Energy or anything else.  Coal doesn't get to power plants without oil.  Only oil matters, to life, to society, to civilization, and there is nothing anyone will ever be able to do about this.

Rule #4.  They don't make it anymore, and never will.  It is God's Cap.  It decides if there is to be an economy forever more.  Its decision is no.

Re-Discovery's picture

Had to junk you.  If you are going to state a broad investment theory, make sure you at least TRY to have some logical and factual bases.

Oil has been used on the planet as it is currently for about 120 years.  There was a 'food supply' before oil.  There was transportation before oil.  There was a huge demand for Coal before oil.  There are any number fo alternative energies that are being developed to circumvent the need for oil.

And guess what was valuable before oil and will be after oil.  Gold and Silver.

CrashisOptimistic's picture

You do not understand.

There was never before 7 billion people to feed.  

Only oil gets the food to them to do that.

When 5 billion of them disappear from starvation, and return to ox pulled plows, they will wish they had oil.  They won't care much about gold or silver because it won't pull the plow.

Re-Discovery's picture

They won't be refining and delivering oil then either.  Please don't start with an investment thesis and end with what happens at armageddon.  Not a strong argument.

CrashisOptimistic's picture

That is somewhat the point.  

Oil is everything.

There is not enough of it to go around.

The conclusion is not "price goes up".

It is people die by the billions.

Blindweb's picture

Billions will die, but slowly over decades.  Third worlders will starve, prescription drug junkies will die from their ailments, infants mortality rates will go up, age expectancy will go down,  WW3 will kill many.  The current monetary system will collapse.  But trade will continue.  The world will fall back on older and silver. 

Milestones's picture

You win set and match.       Milestones

RockyRacoon's picture

Rule #2.  Only Oil Matters.  Sorry PM guys, you are not vital to the food supply.  Only oil is.

I'm not sure that I disagree with this thesis.  I could swallow an argument that the take-down of silver was a diversionary tactic to get at the real objective:  oil.

And if anyone is a PM believer it's me.  Over the long horizon PMs will prevail, but in the immediate time frame oil is the prime mover.  Politics (looking good in an election season) can be a powerful incentive in the markets.

StarvingLion's picture

One can use switchgrass from poor land to power farm equipment.  Transportation system has to be changed due to population density anways. 

The real problem is jobs and the enormous # of people who are tied to the automobile industry.

medicalstudent's picture

great thread.


investing in oil has counterpaty risk.


investing in physical does not.


if we approach endgame, all paper assets will be worth nothing.


virtual world>real world for now.


real world>>>>virtual world for then.



css1971's picture

A doomer! Spotted out in the wild too.

Some things to consider.

1. The peak has taken 100+ years to form. there is still lots of oil. We are going to see decades of inflation and increasing importance of the energy sector.

2: Energy is fungible and electricity is the most fungible form of energy. Internal combustion engines are at best about 30% efficient, whereas electric motors are 90%. Electrical energy transmission and storage systems are improving. For an example of an efficient transport technology see Personal Rapid; . Already installed at Heathrow Airport.

Don't get me wrong, we have trillions in sunk investments in existing agricultural and transport technologies to replace, but I'm not a doomer, nor a cornucopean.

Waterfallsparkles's picture

The problem seems to be in my opinion.  That the price of oil, commodities like copper, aluminum, soft commodities like corn, soy beans, cotton, coffee, etc. need to come down for the average person to survive.  Plus, the Dollar has to rise.

But, all of the above have been the fuel for the Stock Market.  Every time Oil prices ramp up the Market goes with it.  Every time the Dollar goes down the Market goes up.

It is true that Bernanke has padded the pockets of the Banks and the Wall Street traders, but he has forgotten the 95% of the average American.  Unfortunately, the people paying the bill for this ramp in Stock and the depreciation of the Dollar are the average Americans.

It is evident in the earnings reports for most Company's that the higher costs are killing revenues.  They have to raise prices which puts the Consumer in an even greater bind, trying to survive, potential foreclosure, paying their credit cards, paying their car loans. 

This in turn weakens the economy and the Company's on Wall Street earnings.

As more and more people have less and less to spend it will in itself crash Wall Street and all of the Company's listed.  Wall Street can prop these Company's up until tim buck too but eventually it will make its mark with lower earnings, higher debt and no growth.

So, for all of those Wall Street people that think that the hardships of Main Street will never affect their profits, just maybe they should reconsider.

Rusty Shorts's picture

imo silver will be in the low to mid $20 by this fall.

achmachat's picture

I know that you're saying "IMO"... but a baseless line like this is borderline trolling.

If you tell us why you'd think this to happen, we might actually have a real conversation here...

Keri at Bankster Report's picture

I don't know why he thinks that mid-$20 might happen, but I'll tell you why I do, if you're interested.

At the peak last week, the gold-silver ratio was around 1:33.  After this brutal correction, it's back over 41:1, which is still much lower than the usual 55-65:1 we longs have seen over the past several years.  Back in 2008, during the crisis year, the spread was over 80:1, due (in my opinion) mostly to commodity status of silver, and therefore the corresponding position liquiditations when credit dried up and people needed cash.

The Fed has been propping up everything with QEn (n=interger).  There really have been many more than "2."  Supposedly, the spicket is going to be turned off in less than two months.  If gold is going to shine like it should, here is the chance: everyone always makes the "gold doesn't pay a dividend" argument, but no one is going to care about not getting a dividend when all the sudden the support for inflation in "asset" prices like equities and T-bills (and commodities) gets pulled, and instead of increasing or at least treading water every month, these "assets" start to sink.  Like in '08, most people will see it at the same time, and then liquidity becomes an issue (again). As big plays move to gold, they are going to move away from silver, because while silver may be the "poor man's gold," gold is the currency of central banks.

When the rubber meets the road and people start giving a premium to assets that offer wealth preservation over "returns," they move to gold, not silver.  Silver is a wild cat: that's why all of us who bought at $11 or even single-digits love it.  I agree that silver is a monetary metal, but me sitting on my couch leaving comments to that effect are not going to change the minds of the vast majority of people who still say it is solely a commodity.  We went through this with gold: we can all remember when gold was "just another commodity."  Then 2008 and 2009 and 2010 and 2011 happened, and now people understand that gold is not a "commodity."  We're going to have to go through the same process with silver, and it takes time.  And, of course, silver IS more of a commodity than gold (due to its many more numerous industrial applications than gold), which means that with the hit to GDP and jobs and the general outlook for the rest of this year until who-knows-when, it is going to get hit like other commodities.  I don't see copper getting back up to $4.50 a pound, or oil getting back up $120 a barrel.  My guess is as good as anyone's, but on a like note, I think silver will be $25-28 before it revisits $42.  I could be wrong (I'll be glad to be wrong!), but those are my reasons.

And all that said, once silver sees some good support, load up the truck. I don't think $35 is going to hold---not after last week.  I'll be the first to accuse myself if I'm wrong.

Hephasteus's picture

Rusty sold at 20 so that's his valuation of the product. It's really no deeper or wider than that. That's his price.

Rusty Shorts's picture

LMAO, come on man. I doubled my money and still have a nice stash.

Hephasteus's picture

Hey. I'm not faulting you man. You do what you think is right for your situation.

Rusty Shorts's picture

Be as decent as you can. Don't believe without evidence. Treat things divine with marked respect -- don't have anything to do with them.

Do not trust humanity without collateral security; it will play you some scurvy trick.

Remember that it hurts no one to be treated as an enemy entitled to respect until he shall prove himself a friend worthy of affection.

Cultivate a taste for distasteful truths.

And, finally, most important of all, endeavor to see things as they are, not as they ought to be.
      -- Ambrose Bierce