Is Gold Sending Us a Warning?
Is gold sending us a warning?... As goes oil, so go stocks... Why oil companies are hedging again... Recession officially returns...
Yesterday, we saw that gold is now rallying in all major currencies for the first time in years.
Today, we note another important change: The traditional relationship between gold and oil has broken down.
According to an article in the Wall Street Journal, gold and oil usually have a "positive correlation" – meaning they tend to move higher or lower together. This has been especially true over the past five years or so.
This isn't surprising... Oil prices tend to rise during periods of geopolitical turmoil or high inflation, which also tends to increase demand for gold, and vice versa.
But in the past few months, this has reversed. Oil prices have continued to fall, while gold is rising. Why is that?
Perhaps folks are beginning to realize what Porter has been warning about for nearly a year... The latest decline in oil prices – while incredibly positive for the economy in the long term – is a serious problem for the credit markets in the short term.
Gold's recent rally may be just one more sign that a crisis is approaching.
While gold and oil have been diverging, oil's correlation with stocks has been soaring. According to Eric Bush, a portfolio manager at investment-management firm Gavekal Capital, the current link between oil and global stocks – represented by the MSCI World Index – is at its highest level in history.
In other words, as goes oil, so go stocks.
Again, this won't surprise regular Digest readers... As Porter has explained, the energy sector is one of the most important "lions" driving the current market declines.
In the meantime, the volatility in oil prices continues...
Crude was down almost 5% as of midday trading after soaring 7% yesterday.
Monday's rally was attributed to several stories, including more rumors of cooperation between OPEC and other producers to "freeze" production... news that the U.S. "rig count" – the number of oil rigs actively drilling for oil – fell for a ninth straight week... and a report from energy watchdog International Energy Agency ("IEA") that predicted the market would see a "rebalance" of supply and demand by 2017.
As always, we suggest taking these "reasons" with a grain of salt...
As we've discussed, we're skeptical that any significant cooperation between these producers will last.
Despite the latest weekly decline in the rig count, the latest data show U.S. oil inventory continues to increase.
And while the IEA did say it expects declines in production to lead to an alignment of supply and demand by next year, it noted that the huge glut in oil inventories will last well into 2017 and act as a "dampener on the pace of recovery in oil prices." It also admitted its prediction that oil markets would recover last year was "very wide of the mark."
In other words, a bottom in prices could be in by next year... but don't expect prices to soar from here. And if recent history is any indication, the IEA may still be early on that call.
The biggest "miss" in the IEA's 2015 forecast – and those of many others predicting a quick recovery in oil – was the resiliency of the U.S. shale industry.
Like Saudi Arabia and OPEC, the IEA dramatically underestimated how long shale producers would continue to pump more oil.
As regular Digest readers know, this is because of a few important reasons...
First, most shale producers have taken on huge amounts of debt. If they don't bring in revenue, they can't service their debt, and the company goes under.
In simple terms, this means many are incentivized to continue pumping, regardless of the cost, until they default or oil prices recover.
Second, ongoing improvements in technology have dramatically reduced the costs for these producers.
The so-called "breakeven cost" – how much it actually costs shale companies to produce a barrel of oil – varies greatly between different shale regions, but estimates suggest it has plunged to about $45 per barrel on average.
But even this number is misleading... It's skewed by a handful of shale regions with costs above $50-$60 per barrel. According to Bloomberg data, the majority of regions have breakeven costs below $40 per barrel, and nearly half are below $30 per barrel. Some of the best have costs below $20.
With current oil prices near $30 per barrel, many companies are losing far less money than expected... and some are actually still making money. Meanwhile, breakeven costs continue to fall.
Plus, many companies have "hedged" their production at higher oil prices. This means companies have been able to sell their oil at much higher than market prices.
Recently, these hedges have started to expire... but as Porter noted on Friday, most small to midsize firms still have 40%-50% of their production hedged above $60 per barrel.
And incredibly, reports late last week suggest they've been adding new hedges recently as oil prices have bounced. From news service Reuters...
U.S. oil producers reeling from an 18-month price rout have cautiously begun hedging future production this week, fearing this may be their best chance yet to lock in a $45 a barrel lifeline for 2017 and beyond.
As oil markets rebounded from 12-year lows this week, U.S. shale companies – for the first time in months – started inquiring and placing new hedges for the next few years, according to three market sources familiar with money flows...
"The $45 is break-even for a lot of producers. It's not just about making a profit, it's about staying alive," one trader said.
The bottom line is simple: Shale producers shocked the energy world by surviving far longer than anticipated. The latest signs suggest that trend could continue.
Finally, we've discussed how troubles in the energy sector have spread to other markets like high-yield bonds and banks. Now there are signs they're spreading to the real U.S. economy as well.
According to a new report from Moody's Analytics, four U.S. states – Alaska, North Dakota, West Virginia, and Wyoming – are now officially in recession. Three others – Louisiana, New Mexico, and Oklahoma – are at risk of "prolonged declines."
This is a significant reversal from as recently as October 2014, when every state in the U.S. was expanding. As Bloomberg Business reported...
The regions suffering the most are in the flop stage of the energy industry's boom-to-bust cycle, and manufacturing-dependent areas hurt by a rising dollar are at risk of receding. Whether the weak links break the entire U.S. economy will hinge largely on a group that's benefited from the energy price collapse: American consumers.
"The impetus for weakening regional economies is the huge fall in energy prices and other commodities prices, which is taking a tremendous toll," said Joseph LaVorgna, chief U.S. economist at Deutsche Bank Securities Inc. in New York, who is concerned of a broadening into a national recession. "If the consumer were to falter for any reason, that would be a big problem."
New 52-week highs (as of 2/22/16): Franco-Nevada (FNV) and Coca-Cola (KO).
In the mailbag, three e-mails with differing opinions on P.J. O'Rourke's piece about presidential candidate Marco Rubio. Send your criticisms and praise to feedback@stansberryresearch.com.
"Mr. O'Rourke you must be joking? Are you not paying attention? You say that Rubio should be laughing at the political establishment? Rubio is part of the establishment, maybe not the old guard but the next generation of career politicians. Look at who endorsed him in South Carolina, if Rubio were not part of the establishment he would have Tea Party people endorsing him.
"Rubio can not tell or show us what a bunch of clowns we have in government because that would mean he would see his reflection in the mirror. You are right in that, 'People make! Government Take!' Rubio is a taker not a maker. He is a career politician so therefore he is part of the problem!
"All you need to know is this... when Rick Santorum quit the race he endorsed Rubio, when asked to name 3 accomplishments of Marco Rubio... he could not. Rubio is a robot in an empty suit." – Paid-up subscriber Steve Hoffmann
"P.J. O'Rourke, YOU NAILED IT!!! I couldn't have said it better myself – I'm not clever enough." – Paid-up subscriber Chuck W.
"P.J., I couldn't agree with you more about the GOP blandness. However, I'm confused. Wouldn't all that brash talk and those colorful metaphors you suggest Marco Rubio employ result in John McCain getting up into Marco's grill and calling him a 'wacko?' Wouldn't it result in John Boehner commenting to a bunch of political operators about Marco's, um, unsavory personality? Surely, Donald Trump would label him a 'liar.'
"Here we are again. We want someone to stand up and shout 'NO MORE,' but when they do, those same people complain that the interloper cannot 'get along' with all the other kids. The same kids, by the way, who mowed the neighbor's lawn instead of yours and plugged your car's tailpipe with the wet sponge. These are the kids that someone like you describe would surely offend. Then they would tell their parents about their offense, and their parents would complain. Before you know it, poor Marco would be labeled as someone who just 'can't get along with others' and is 'too extreme to be President.'
"Which is it? Do we want to support someone who can 'work' with all these idiots in Washington who have created this mess? Or do we want someone who is going to offend them all by illustrating just how asinine their 'governing' has been for the last century?" – Paid-up subscriber Russ A.
Regards,
Justin Brill
Baltimore, Maryland
February 23, 2016
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