Over the past year we’ve talked a lot about the oil price bust and the threat it represented to the global economy. And in past months, we’ve talked about the approaching OPEC meeting, where they had telegraphed a production cut – the first in eight years. Still, not many were buying it.
Remember, it was OPEC created the oil price crash that started in November of 2014 when the Saudis refused a production cut. Ultimately the price of oil fell to $26 a barrel (this past February).
Their strategy: Kill off the emerging threat of the U.S. shale industry by forcing prices well below where they could produce profitably. To an extent it worked. More than 100 small oil related companies in the U.S. filed for bankruptcy over the past two years.
But it soon became evident that cheap oil threatened, not just the U.S. shale industry (which also turned out to threaten the global financial system and global economy), but it threatened the solvency of OPEC member countries (the proverbial shot in the foot).
The big fish, the Saudis, have lost significant revenue from the self-induced oil price plunge, starting the clock on an economic time bomb. They derive about 80% of their revenue from oil. With that, they’ve run up their budget deficit to more than 15% of GDP in the oil bust environment. For context, Greece, the well known walking dead member of the euro zone was running a budget deficit of 15% at worst levels back in 2009.
So OPEC members need (have to have) higher oil prices. Time is working against them. With that, they followed through with a cut today. Remember, back in the 80s when OPEC merely hinted at a production cut, oil jumped 50% in 24 hours. Today it was up as much as 10% on the news. But this cut should put a floor under oil in the mid $40s, and lead to $60-$70 oil next year.
All of this said, given the increase in supply from bringing Iran production back online, and from increasing U.S. supply, no one should be cheering more for the pro-growth Trump economy to put a fire under demand than OPEC, especially Saudi Arabia.
Now, as we discussed this week, oil has been a huge drag on global inflation. With that, the catalyst of a first OPEC cut in eight years driving oil prices higher could put the Fed and other global central banks in a very different position next year.
Consider where the world was just months ago, with downside risks reverting back to the depths of the economic crisis. Now we have reason to believe oil could be significantly higher next year. That alone will run inflation significantly hotter (flipping the switch on the inflation outlook). Add to that, we have a pro-growth government with a trillion dollar fiscal package and tax cuts entering the mix.
As I said yesterday, we may find that the Fed will tell us in December that they are planning to move rates more like four times next year, instead of two.
The market is already telling us that the inflation switch has been flipped. Just four months ago, the 10 year yield was trading 1.32%, at new record lows. And as of today, we have a 10-year at 2.40% — and that’s on about a 60 basis point runup since November 8th.
With that said, there has been a shot in the arm for sentiment over the past few weeks. That’s led to the bottoming in rates, bottoming in commodities and potential cheapening of valuations in stocks (given a higher growth outlook). As a whole, that all becomes self-reinforcing for the better growth outlook story.
And that reduces a lot of threats. But it creates a new threat: The threat of a collapse in bond prices, runaway in market interest rates.
But what could be the Fed’s best friend, to quell that threat? Trump’s new Treasury Secretary said today that he thinks they will see companies repatriate as much as $1 trillion. Much of that money will find a parking place in the biggest, most liquid market in the world: The U.S. Treasury market. That should support bonds, and keep the climb in interest rates tame.
We may be entering an incredible era for investing. An opportunity for average investors to make up ground on the meager wealth creation and retirement savings opportunities of the past decade, or more. For help, follow me in my Billionaire’s Portfolio, where you look over my shoulder as I follow the world’s best investors into their best stocks. Our portfolio is up 24% year to date. That’s more than three times the performance of the broader stock market. Join me here.
The markets are sitting on Apple earnings, which will come after the close today (by the time you read this).
We’ve been talking about the quiet move in currencies, some commodities and some foreign stock markets.
Given that the dollar is looking like another (maybe big) run is in store, which means much lower euro and much lower yen (and higher German and Japanese stock markets, as we’ve discussed), what does a higher dollar mean for commodities?
Commodities have, of course, been crushed throughout this post financial crisis period. And earlier this year, oil was the most recent mass declining commodity. That was after an initial collapse in 2008, and a sharp recovery from 2009 through much of 2014. But then of course, it came crashing back to earth to revisit the deeply depressed levels of most other commodities, following OPEC refusal to cut production back in late 2014.
So, we’ve talked about the importance of oil. Cheap oil had all of the ingredients to be even more destructive to the global economy than the credit bubble burst (and housing bust). But it’s out of the danger zone now, at around $50, and the outlook is bullish, given the supply dynamics and given that OPEC is prepared to cut for the first time in eight years.
So this begs the question: If the dollar is strengthening, and may continue to strengthen, isn’t that bad for commodities? And therefore, isn’t that bad news for the oil price recovery?
The mainstream financial media usually is very quick to attribute moves in commodities to an inverse move in the dollar (and vice versa). On the surface, it’s a logical enough argument. After all, commodities like gold, oil, and grains are all priced in dollars.
Therefore, if the dollar weakens the value of the commodity shouldn’t be penalized. With that logic, it should strengthen to maintain its value on the global stage.
So all things remaining equal, the commodity should move in the directly proportional opposite direction of the dollar.
The only problem with this argument is that all things never remain equal …
So is there a legitimate price relationship between the dollar and commodities? Or is it just market fodder to attempt to explain and justify the market activity?
That depends on the time period you look at …
For example, from December 1998 to September 2000 the relationship of oil and the dollar was positive, as shown in the chart below. When one went up, the other went up.
On the other hand, from 2006 to 2009, the relationship was been negative. Take a look at the following chart: When oil was crashing, the dollar was rising sharply. And toward the far right of the chart, oil recovered and the dollar fell.
Of course, these are just two isolated periods of time that I’ve used here to demonstrate exact opposite relationships.
However, over longer periods the influence of the dollar on oil, or oil on the dollar, is found to have NO statistical significance. There’s not a significant positive or negative correlation. Consequently, statisticians would conclude that the dollar and oil have nothing to do with one another.
So there is no reason to believe oil can’t continue its strong recovery, and do so in an environment when the Fed is moving in the opposite directions of other major central banks, providing fuel for a much higher dollar.
Click here to get started and get your portfolio in line with our Billionaire’s Portfolio.
As you might recall, since I’ve written this daily note starting in January, I’ve focused on a few core themes.
First, central banks are in control. They’ve committed trillions of dollars to manufacture a recovery. They’ve fired arguably every bullet possible (“whatever it takes”). And for everyone’s sake, they can’t afford to see the recovery derail – nor will they. With that, they need stocks higher. They need the housing recovery to continue. They need to maintain the consumer and growing business confidence that they have manufactured through their policies.
A huge contributor to their effort is higher stocks. And higher stocks only come, in this environment, when people aren’t fearing another big shock/ big shoe to drop. The central banks have promised they won’t let it happen. To this point, they’ve made good on their promise through a number of unilateral and coordinated defensive maneuvers along the way (i.e. intervening to quell shock risks).
The second theme: As the central banks have been carefully manufacturing this recovery, the Fed has emerged with the bet that moving away from “emergency policies” could help promote and sustain the recovery. It’s been a tough road on that front. But it has introduced a clear and significant divergence between the Fed’s policy actions and that of Japan, Europe and much of the rest of the world. That creates a major influence on global capital flows. The dollar already benefits as a relative safe parking place for global capital, especially in an uncertain world. Add to that, the expectation of a growing gap between U.S. yields and the rest of the world, and more and more money flows into the dollar… into U.S. assets.
With that in mind, this all fuels a higher dollar and higher U.S. asset prices. And when a dollar-denominated asset begins to move, it’s more likely to attract global speculative capital (because of the dollar benefits).
With that in mind, let’s ignore all of the day to day news, which is mostly dominated by what could be the next big threat, and take an objective look at these charts.
U.S. Stocks
Clearly the trend in stocks since 2009 is higher (like a 45 degree angle). Since that 2009 bottom in stocks, we’ve had about 4 higher closes for every 1 lower close on a quarterly basis. That’s a very strong trend and we’ve just broken out to new highs last quarter (above the white line).
U.S. Dollar
This dollar chart shows the distinct effect of divergent global monetary policy and flows to the dollar. You can see the events annotated in the chart, and the parabolic move in the dollar. Any positive surprises in U.S. economic data as we head into the year end will only drive expectations of a wider policy gap — good for a higher dollar.
Oil
We looked at this breakout in oil last week after the OPEC news. Oil traded just shy of $50 today. That’s 17% higher since September 20th.
Oil trades primarily in dollars. And we have a catalyst for higher oil now that OPEC has said it will make the first production cut in eight years. That makes oil a prime spot for speculative capital (more “fuel” for oil). And as we’ve discussed in recent days, weeks and months… higher oil, given the oil price bust that culminated earlier this year, is good for stocks, and good for the economy.
What’s the anti-dollar trade? Gold. As we discussed yesterday, gold has broken down.
If we keep it simple and think about this major policy divergence, we have plenty of reasons to believe a higher dollar and higher stocks will continue to lead the way.
The Billionaire’s Portfolio is up 23% year-to-date — that’s nearly four times the return of the S&P 500 during the same period. We recently exited a big FDA approval stock for a quadruple, and we’ve just added a new pick to the portfolio — following Warren Buffett into one of his favorite stocks. If you haven’t joined yet, please do. Click here to get started and get your portfolio in line with our Billionaire’s Portfolio
