DOW hits new high - long-term don't hold your breath, but low oil helps


“Mankind is facing a crossroad - one road leads to despair and utter hopelessness and the other to total extinction.” – Woody Allen"


Lots of excitement over the jobs number today, mainstream analysis shows there were more people working, they are working longer, and getting paid more. The realist (labeled a pessimist by many) would point out that ‘quality’ of jobs was very weak; the job numbers released today were top-heavy with secretaries, waiters, retail, education, leisure and temporary help. Plus full-time jobs are down 150,000, the labor participation rate remains at 35 year lows, and young men are not welcome in this market. The other noteworthy economic data set released today was U.S. factory orders which came in poorly; U.S. Factory Orders tumbled 0.7% in October (missing 0.0% expectations) for the 3rd month in a row (for the first time since June 2012) (Non-durable orders -1.5%, non-defense, ex-air tumbled 1.6%, and inventories-to-shipments levels are at the year's highs. More problematically for GDP enthusiasts, October inventories of manufactured non-durable goods decreased 0.5% to $249.0 billion driven by petroleum). Rather notably, the only other time we had 3 straight months of factory orders declines was in the recession and the 2012 decline was saved by QE3.

Since a prudent well diversified long-term investor always has skin in the game in all sectors, the question to ask is "should I be 'all-in'?" (heck, the DOW closed at record highs again today) – the answer to that is personal, however my opinion is ‘heck NO’, as sometimes the best investment is the investment you don’t make. Oil prices being lower is good for consumer confidence/affordability and business (low oil has always been a big boost to economies that use oil), however the oil price is only this low because Saudi Arabia has allowed it to be so (due to geopolitical motivation and desire to crush enemies of its friends and competition) and lower oil prices are helped from global economic growth being weaker too. We note motor vehicle sales numbers were strong this week, but that is on the back of a rise in sub-prime auto sales. You see, every economic number has a yin and a yang – the markets are just looking at the yin (today). In fact, if the 'positive' jobs number came out a year ago like it did today, the markets would be down on anticipation of rate hikes – so the question now is why did it not do that today? (the markets rallied today on the good jobs numbers) -- Many pundits believe the fear of higher rates is being trumped by the physiological shift in the investment community that rates nudging-up towards more normal interest rate levels is healthy and that we are still at near zero (1/4 of a percent) and that no real harm will be done until rates hit much higher. The pessimistic economists of this world believe this is wishful thinking, and when the reality of the wishful thinking becomes apparent and the reality that Fed is truly backed into near-zero rates forever without major structural earth-shattering reforms in entitlements and spending and whatnot (things the current administration is incapable of) – things will unravel. When that unraveling happens could be Q1-2015 (in a long slow tug of war train wreck -- however the year prior to a US Presidential election is typically bullish) or Q1-2016 (in a more violent fashion), but would not bet against it not happening.


S&P 500 Comments: S&P 500 Index sits at 2075.37,

S&P 500 Large Cap Index - 3 year chart with Moving Averages, & Chaikin Money Flow:$SPX&p=D&yr=3&mn=0&dy=0&id=p13321123378

To see an interactive heat map of the individual companies making up the S&P 500 (by price performance) click here


Oil Comments: WTIC sits at US$65.63/barrel,

West Texas Intermediate Light Crude - 3 year chart:$WTIC&p=D&yr=3&mn=0&dy=0&id=p97974250530



Focus on Oil - What happened?

Up until 2014, we had been producing less than what the world demanded. Prices rose as a result.


World oil demand was 92.8 million barrels when the year began. World supply tipped above this at 93.0 million barrels per day in October (source: Oil Market Intelligence), putting the world in surplus. Most of this came from the US and Canada. The demand side also flattened. China is slowing and we are all driving more economical cars.


This chart shows the oversupply OPEC is staring at. Thanks to North America, up to 2 million extra barrels per day could be sloshing around by 2016:



Over 80% of non-OPEC new production was from the US shale formations. Faced with this new threat to its dominance, Saudi Arabia decided to take action. They decided to continue to pump to drive prices down, thereby forcing US production to slow. The Saudis also have long memories. In 2009, they cut production to lift oil prices after crude fell to $30 per barrel in the financial crisis. The Russians took full advantage when prices rose, raising production to steal market share. If today’s rout hurts Russia, the Saudis could just say they are settling an old score. 

In a normal market, the decline would have been modest. But in today’s finance-driven world, where the oil futures market is 18x the size of the physical oil market, all hell broke loose. Oil plunged $10 a barrel in just two days as hedge funds were wiped out and dumped their positions.


Oil stocks reacted just as badly. Companies needing $90 oil to make a profit suddenly realized they could be bankrupt at $65. To balance the world’s supply and demand, US and Canadian production has to stop growing. And judging by the headlines of budget cuts and drilling delays, this is exactly what we are about to see.
Is this good or bad for the world?


Lower oil prices are unequivocally good for most of the world.


Look at what happened the last time oil prices were flat. It began when the Saudis drove the price of oil down in 1986. Oil then traded in a range for 14 years as the excess capacity discovered in the 1970s was worked off -- economies that use oil loved it and general stock markets during that period reacted.


Is this the bottom?

This question is harder to gauge. Technically, crude oil has fallen too far, too fast, suggesting a bounce is likely. Most analysts suggest the world needs oil to be priced between $75-90 to be economically viable. We may not be running out of oil, but we are running out of cheap oil. Here is a quick comparison of the costs of new oil projects (data from CERI):


• $74 U.S. shale oil average
• $85 Steam-driven oil sands (SAGD)
• $105 Oil sands open-pit mine
• $99-127 Ultra-deep offshore
• $103-113 Arctic oil

On average, the world’s Top 20 undeveloped oil projects will require an average of $95 per barrel to develop (Carbon Tracker). Worldwide oil production depletes at about 6.7% per year (IEA 2008 World Oil Report).


Shale oil is even worse. These wells decline as much as 70% in the first year (think of the initial fizz from a bottle of champagne and how quickly it fades). The US will slow its rate of drilling, but it can’t stop. Shale oil firms are trapped on production “gerbil wheels” - they need to keep drilling just to keep production from falling. Schlumberger (NYSE SLB), the world’s largest drilling firm, said recently that “4 of 5 U.S. shale wells are required just to keep production flat.” It won’t take much of a drop in activity to slow US production growth, and it could happen quickly. New Texas drilling permits fell 50 percent in November (FuelFix), the first decline in new Texas drilling permits seen in the past year.


Many projects have already been budgeted and contracted, so production will not drop right away. Also, many companies eager for growth overpaid for their properties. We will see these over-indebted companies suffer in the months ahead.


This suggests that prices can stay down in the short-term, but won’t stay down in the long-term. Saudi Arabia and OPEC have a limited tolerance for the pain of low oil prices. After pumping extra oil to flood the market in 1986, they were cutting production within a year. In 2009, oil prices had recovered to $80 within 6 months of hitting bottom.


Watch first for cutbacks, rallies and declines in oil stock prices that go nowhere, a few bankruptcies, and then takeovers. After a prolonged slump in prices, and the collapse in production that always accompanies such a slump, we get set up for yet-another jump in prices. The world is balanced around $80-90 per barrel. Any time below that is likely temporary.


The conclusion on oil here is: buckle up for the next six months. Russia is already ramping up oil production to compensate for the lower price, which only makes matters worse. Many companies will keep pumping until they are told by their bank loan officers to stop. Much of the damage is already done (to stock prices) but expects the price slump to last at least through the spring.


Natural Gas Comments: The price for natural gas is US$3.78/Thousand cubic feet,

Natural Gas - 3 year chart:$NATGAS&p=D&yr=3&mn=0&dy=0&id=p73380874388


Gold Comments: Price of Gold is US$1,192.60/oz,

Gold - 3 year chart:$GOLD&p=D&yr=3&mn=0&dy=0&id=p36938539348


Silver Comments: Price of Silver is US$16.28/oz, to see 3 year chart of silver click here


Bonds Comments: The yield on10 Year US Treasury notes sits at 2.31%,

10 Year US Treasury Yield - 1 year chart:$UST10Y&p=D&yr=1&mn=0&dy=0&id=p96945963610


Currencies as of Dec 5, 2014:


AUD/USD : [chart] 1 AUD = 0.8276 USD

Looking for AUD to weaken more; target 0.81


USD/CAD : [chart] 1 USD = 1.1450 CAD

A close below 112 USD/CAD will cancel the sell signal, short term

EUR/USD : [chart] 1 EUR = 1.2280 USD

USD/JPY : [chart] 1 USD = 121.4150 JPY

as long as there is no close below 118 USD/JPY we expect more Yen weakness


 The Silent Quotient

  Sector Rotation Journal ##


Articles, excerpts, commentary and reviews herein are for information purposes and are not solicitations to buy or sell any of the securities mentioned. Readers are cautioned that every idea communicated herein involves risk and uncertainties. Opinions and predictions and may differ materially from actual events or results.


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