Citi On The Coming "Black" Gold-Rush
The present picture for the oil price looks increasingly bullish once more. Citi asks, is this a replay of the dynamics seen in the 1970’s? We hope not...
Via Citi FX Technicals,
Brent Crude chart breaking out like 2007?
Following a surge in the Oil price over about 3 years from 2003 to 2006 (Post the Equity market collapse of 2000-2002 and the accompanying aggressive Fed easing) when Crude virtually tripled in price, we saw a correction into 2007 that fell just short of the 200 week moving average. This became a platform for the next move higher. This move was once again a virtual tripling in price but in half the time of the 2003-2006 move (18 months) between 2007-2008.
With a backdrop (In hindsight) that was weakening dramatically this was the “straw that broke the camel’s back” as the negative feedback loop moved through housing, the equity market, economic data and employment.
That resulted in a subsequent collapse in the Oil price into late 2008 before we saw a similar cycle start all over again.
Following a surge in the Oil price over about 3 years from late 2008 to early 2012 (Post the Equity market/housing/economic collapse and the accompanying aggressive Fed easing) when it more than tripled in price we saw a correction into 2012 that fell just short of the 200 week moving average. This became a platform for the next move higher that began in June of 2012.(We re-tested the 200 week moving average in April-July this year but have since rallied strongly again off that level)
The price of Brent is now up about 20% from the April 2013 levels (up 16% since June alone) and looks to be breaking out to the topside with the move above resistance in the $114 area. Interim resistance is met at $117.95-119.12 (Sept 2012 and Feb 2013 highs) and then $127-128.40 (Peaks in April 2011 and Feb 2012.) A weekly close over this latter range would open up the way for accelerated gains.
If we look at our favoured historic comparison of the 1970’s, Crude virtually tripled in price over 18 months in 1973-1974 (The Equity market and housing markets collapsed in this period and economic data collapse in a fashion similar to that seen in 2007-2008)
Crude subsequently fell away only to start another 18 month period where it tripled in price between 1978 and 1979 (5 years later)
2007-2008 triples over 18 months. Five years later 2012-2013 surge in Crude????
So we have to be honest and say that we feel somewhat reluctant to believe that Brent is once again going to triple over an 18 month period. Such a move would suggest a price level somewhere in the region of $265 by the end of 2013. Even to us that sounds a bit aggressive.
However if you look at the price action above and anticipate even a move of similar fashion to 2007-2008 on a linear basis ($100 higher) that could still leave us in the region of $185-190 (by the end of 2013 would still seem a difficult target)
The surges of 1973-1974, 1978-1979 and 2007-2008 all resulted in deep recessions as the economy could not bear the weight of such a large move in such a short period. Also, importantly, the surge in 1978-1979 was not an economic growth/demand driven dynamic but rather a supply shock. It came on the back of the Iranian revolution which disrupted the Iranian oil sector and a ban on Iranian imports subsequently by President Carter. This scenario was exacerbated further by the outbreak of the Iran-Iraq war in 1980. The US economy suffered a backdrop of stagflation in this period as the Paul Volcker Fed aggressively reacted to this scenario with higher interest rates (a move we feel 100% comfortable that this Fed will not repeat)
Most importantly this backdrop together with our concerning “Techamental” charts articulated in recent months suggests to us that a rise in Brent for “economic reasons” looks unlikely. This leads us to conclude that either:
The view of higher Oil prices is incorrect
The move higher is going to be the result of a “supply shock” as in 1978-1979. This at a time when US economic growth has eased and our ‘Techamental” charts suggest the potential for deteriorating economic data and employment in the months ahead. Add this to the recent tax rises and future possible spending cuts and it seems likely that such a surge in Oil would have a very negative economic feedback loop. Oil, if anything, has a much quicker transmission mechanism into the economy than either monetary or fiscal policy, especially if the move is “speedy”
Right now the most obvious concern is the dynamic in Syria. This is not because Syria is a big Oil producer (It is not) but it is a country caught between the loyalties of Russia and Iran on one side and the US and Saudi Arabia on the other. An escalation here (At the same time as Egypt has become unstable again) would raise concerns about the danger of “spillover” effects. All that is before we even revisit the Iranian nuclear situation.
Even if we look at $185-190 as a stretch by year end (Albeit not beyond the realms of possibility) even a move back towards the all-time highs around $147 with:
- Unrest in the Middle East
- Financial stress in LM and in particular Asia
- Fiscal drag from the sequester and tax rises
- Debt limit/ budget negotiations
- Potential Fed tapering
- A new Fed Chairperson
- German elections
- Europe (Periphery etc.)
...would be a relatively instantaneous and in our view unbearable drag on the Global economy i.e. a game changer.
This picture could be even worse when it comes to Europe. Europe is much more dependent on Brent while the US is more tied to Nymex.(Although Gas prices (Petrol in Europe) tend to be tied closely to the move in Brent)
Brent crude versus Nymex spread
The narrowing this year in this spread did NOT come from a falling Brent price as most people expected but rather a rise in Nymex.
Now the spread appears to be breaking out led by the rise in Brent. At a minimum we would expect the 55-200 day moving average gap to be closed. This would suggest a widening in this spread to at least $12-13 from the present $5.70 area.
Brent in EUR terms
Breaking out with momentum. Good resistance at EUR 87-89.5 and then EUR 94.5 to 96.5
Worth noting that while Brent is still over 20% from its all-time high in USD terms it is only less than 10% from its all-time high in EUR terms... and surging in JPY, IDR, and INR terms of course... (India imports about 80% of its Crude Oil requirements according to India’s Minister of Petroleum and Natural Gas)
Brent in INR terms
Looks like they are stuffed... But the US still has a problem...
Oil and the feedback loop to the economy and markets
Consumer Confidence and the Oil price
Previous moves down in consumer confidence (2000 and 2007) both came with “expensive” oil prices
The break higher in Oil at the end of 1999 / early 2000 also saw a peak in confidence
The 2007 break higher on Oil came just after the peak in confidence but as Oil continued to rally, confidence fell.
This time we have only broken through short term levels on Oil and not the more important ones yet at $119 and $127-$128.40 (Although we may have already peaked in consumer confidence as per our 4 year 4 month cycle)
What this chart shows is that there comes a point in an Oil uptrend whereby higher prices are no longer seen as an indication or reflection of economic growth or progress but instead seen as a threat to stability.We seem to be close to this point.
Oil and the S&P 500
Clearly the two are not “correlated” from a long term perspective. We can find periods where the S&P 500 and Oil moved in the same direction and periods where they moved in opposite directions.
A closer look at the breakouts in Oil however may reveal something else (in red)
Each of the three previous major breaks in Oil (1990, 2000 and 2007) saw the rallies in the S&P 500 stall. Of course there were a number of other factors at work in those periods (just as there are now) which all played important roles in determining the characteristics of the bear markets that followed on the S&P 500. However it seems that within an Oil uptrend, there comes a point where higher prices are no longer seen as a positive but instead a negative development. A “tax” on the consumer.
While we have only seen a short term break in oil at this stage, a rally through $119 and in particular $127-$128.40 on Brent would be an important bullish break on a larger scale
This chart effectively makes the same point as the overlay of Oil and consumer confidence seen earlier. It is therefore consistent with the one below
Consumer confidence and the S&P 500
The obvious point this chart makes is that the level of the S&P 500 does not reflect the relative confidence of consumers
While consumer confidence has just recently posted a trend high, it is significantly below the 2007 high while the S&P 500 is trading above levels from 2007
The second point is that the Equity market trends down when consumer confidence turns down
In 2000, Equities peaked first in March and consumer confidence posted a double top in May. Equities did not trend down aggressively until consumer confidence fell away
In 2007, consumer confidence peaked in July and the Equity market made a marginal new high in October. That high was unsustainable and we saw a peak as confidence also collapsed.
Note: Watch the DJIA close this month. IF it closes below 14,858 it would be a bearish monthly reversal off the high of the trend. While not needed it would enhance the concerns noted above. (Monthly reversal levels on other indices (less likely) would be: S&P 1,604: NDX 2,913; Transports 6,170
Once Consumer confidence turns, the Equity market has been unable to sustain new highs. So we may have to wait for consumer confidence releases in the coming months for confirmation . If indeed the measure turns lower (after 4 years and 4 months of gains like the last 2 cycles) then we would be careful with the sustainability of an elevated S&P 500. In 2000-2007 the equity market turned sharply lower within 3-4 months of the peak in Consumer confidence. If that was indeed the peak in consumer confidence in June then it does not augur well for the Equity market in Sept-Oct.
Factors that are likely to impact Consumer confidence include mortgage rates and the Oil price as these have a significant impact on disposable income
Mortgage rates have already risen substantially
While only a short term break has been seen on Oil, we are concerned about the medium term set up. A break through $119 and more importantly $127- $128.40 on Brent will be very bullish and could send the Oil price back towards the 2008 highs
This will effectively be a “tax” on growth and even worse in those countries that have seen their currencies drop sharply in the last 3-9 months.
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