New Worries From China
New worries from China... A repeat of last summer's crash?... Why oil is plunging again... The latest from P.J O'Rourke...
Editor's note: Be sure to read to the bottom of today's Digest for the latest from contributing editor P.J. O'Rourke.
Like we noted on Monday, stocks around the world declined again today.
And like Monday's, today's decline was mostly blamed on China...
A report this morning showed China's services activity was much weaker than expected. According to the Wall Street Journal, the Caixin/Markit China Services Purchasing Managers' Index fell to 50.2 in November – that's a little more than 50, the level that separates expansion from contraction.
These are the weakest data from China's service sector since July 2014 – and the second weakest since record keeping began in 2005 – and they mirror the unexpectedly weak manufacturing data blamed for Monday's selloff.
China's currency, the yuan, also plunged to a new all-time low against the U.S. dollar. We'll take a closer look at the reasons behind the decline in the yuan – and what it could mean for U.S. investors – in tomorrow's Digest.
Regular readers will recall the big drop in the yuan last August preceded the crash in U.S. stocks, where the benchmark S&P 500 Index fell more than 10% in less than two weeks.
We're not foolish enough to predict a replay of last summer's crash... But we can't help but notice the similarities.
Since peaking on December 29, the S&P 500 has fallen 4.3% in just five trading days. The Dow Jones Industrial Average has lost nearly 1,000 points over the same time period, a steep decline on pace with the first days of August's selloff.
We continue to recommend caution.
Yesterday, we took a look at some new signs of trouble in the energy sector. Today, we note another...
West Texas Intermediate ("WTI") crude oil – the U.S. benchmark for oil prices – fell more than 4% back below $35 per barrel. Brent crude oil – the international benchmark – fell nearly 6% to a new 11-year low. It's now also trading at less than $35 a barrel for the first time since 2004.
Brent crude typically trades at a premium to WTI, but after today's decline it trades for less than $0.50 per barrel more.
Oil prices spiked to start the week after reports of new turmoil in the Middle East...
As you may have heard, on Sunday, Saudi Arabia executed 47 men – including a prominent Shiite cleric – which led to a promise of "harsh revenge" from Iran.
While the details of the situation are beyond the scope of the Digest, this triggered fears of a new conflict between several of the world's most important oil producers.
But the spike was brief. By Monday afternoon, prices were falling.
You may be wondering why that's the case...
While geopolitical turmoil has historically been bullish for oil – war tends to increase demand and disrupt supplies – the near-term effects of this news are likely to add to the bearish factors we've been following.
We've discussed how Saudi Arabia and the rest of OPEC are engaged in a game of "chicken" with U.S. shale oil producers. The expectation has been that sooner or later – once enough damage had been done to the shale industry – OPEC would agree to reduce production to halt the decline in prices.
But Iran is also a member of OPEC. And with the country likely to resume oil production this year following the easing of sanctions, this conflict makes it even less likely OPEC members will work together to reduce production. As one analyst told the Financial Times...
If anything, these tensions between Saudi Arabia and Iran are the nail in the coffin for any OPEC coordination. There is no appetite for a reduction in production. We will see strong exports out of Saudi and extra volumes from other OPEC members in 2016.
But that's not the only reason to believe oil supplies will stay high – and oil prices will stay low – for some time...
A report this weekend showed Russia – one of the world's biggest non-OPEC producers – is also pumping record amounts of oil. Despite low prices, the country produced 10.8 million barrels of crude and gas condensates last month, the highest monthly total in the post-Soviet era.
It seems counterintuitive, but as our colleague Matt Badiali, editor of the Stansberry Resource Report, explained in a private note, it makes perfect sense. Countries like Russia (including many OPEC countries) are dependent on energy revenue. Low prices means they have to produce more oil to hit their revenue numbers, no matter what.
Finally, we should note that the 40-year ban on U.S. oil exports has finally been lifted.
Just before the holiday, Congress agreed to remove the ban, and on New Year's Eve the first barrels of oil left the U.S. As the Wall Street Journal reported...
The first oil tanker of freely traded U.S. crude departed Thursday afternoon from the Port of Corpus Christi, about 160 miles north of the Texas border with Mexico.
ConocoPhillips Co. and NuStar Energy LP loaded the tanker with oil pumped from the Eagle Ford Shale of South Texas. The companies have skipped ahead of Enterprise Products Partners LP, which said last week that it expected to load the first oil export cargo in Houston during the first week of January.
The immediate effect of U.S. exports will be a change in the relationship between WTI and Brent crude prices. As Matt told Stansberry Resource Report readers in the December issue of his MLP Value Monitor...
As we write, the Brent-WTI spread (the difference between the international-standard Brent crude oil price and the local-standard West Texas Intermediate crude oil price) has fallen considerably. This is a big deal.
Brent has traded at a premium to WTI since the second half of 2010. Foreigners will pay more for WTI now that it's available because it's higher quality than Brent – it's lighter and sweeter.
Light oil is less dense than heavy oil, and sweet oil has less sulfur than sour oil. Refiners prefer light, sweet oil for its ease of processing. It's cheaper and more efficient to refine oil that is less dense and contains fewer unwanted particles.
This is already happening, as we mentioned earlier. Don't be surprised if WTI eventually trades at a significant premium to Brent.
Ultimately, U.S. exports will be incredibly bullish for oil prices... and for U.S. oil producers in particular. But don't expect an immediate reversal. As Matt summed it up for his subscribers...
The world still produces more oil than it needs. We need to see supply move back in line with demand to see prices move significantly higher.
New 52-week highs (as of 1/5/16): short position in Capital One Financial (COF) and short position in iShares MSCI Canada Index Fund (EWC).
Another quiet day for the mailbag. Are you panicked about the last five trading days? What in your portfolio is holding up during this pullback? Send us a note at feedback@stansberryresearch.com.
Regards,
Justin Brill
Baltimore, Maryland
January 6, 2016
Lesson from a Gold Souq
Is it better to make a fancy investment or a plain one?
By "fancy," I mean an investment that grabs your eye because it's brilliant, shiny, bright, new, beautiful, and elaborate.
By "plain," I mean an investment that just is what it is.
"Fancy" and "plain" aren't investment terms you're likely to find in Barron's or on CNBC. And those guys probably have 100 different ways to talk around that question...
But I'm just a former foreign correspondent... not an investment maven. And I got a simple lesson in fancy and plain investments the first time I visited a Middle Eastern gold souq.
In the cities of the Middle East, merchants selling a particular commodity will all gather in a single marketplace, in Arabic, a souq. A city has a gold souq, a fruit and vegetable souq, a carpet souq, a clothing souq, and so on.
In August 1990, I was in Dubai in the United Arab Emirates, covering the aftermath of Saddam Hussein's invasion of Kuwait. After I had interviewed as many Kuwaiti refugees as I could find, there wasn't much else to do. So I visited the gold souq.
Dubai was not yet the vast, towering metropolis it would become. But it already glittered with oil wealth... especially in the little shops along the narrow, awning-covered streets where the old gold souq was located. (There's a skyscraper there today.)
Even the smallest shops appeared to have a million dollars' worth of gold jewelry on display. I had never seen so much gold. And I had never realized how powerfully attractive gold is.
All the gold for sale was 24 karat – 99.99% pure. The merchants of Dubai deal in nothing else. Pure gold has a fiery look. It seems to glow from within. The array of bracelets, pendants, rings, chains, medallions, and brooches was like a sunset on a shelf.
I felt as if I suddenly understood gold. But what I didn't understand was the gold-souq prices.
One wonderful filigree necklace was made with delicate threads of gold worked into a sort of heavenly angel's lace collar. This was for sale at a bargain price. Next to it was an unadorned amulet selling for much, much more.
I saw the same thing repeatedly. A pair of earrings displaying exquisite craftsmanship – cheap. Smooth gold hoops – pricey. A locket too pretty for Tiffany's – a pittance. Another you might find in Wal-Mart – a bundle.
I looked around until I found a shop owner who spoke good English. But for a while, it was as if I couldn't make him understand my question about why one fabulous piece of jewelry was inexpensive, while another ugly one cost so much.
"Oh!" he said at last, "the price. It is the London gold market. We check on the financial wire service. Then we use this scale."
"But this is plain," I said, pointing to a large, clunky bangle. "While this," I said, pointing to a delicate armlet the creation of which must have required the best efforts of a skilled goldsmith, "is fancy."
"Fancy?" said the gold merchant. "Price is weight. Fancy is free of charge."
Regards,
P.J. O'Rourke
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