Crude follow up.

This Sunday we’re trying to make some sense of the near-term situation re crude prices.

We believe that course-of-least price resistance is to remain north, certainly until the Mar/5 meeting, Netanyahu / Obama.

Netanyahu has the past few weeks, singlehandedly, made the Iranian nuke situation the central focus of the Western world, convincing all that this is the key concern now. Some believe that if Netanyahu leaves that Mar/5 meeting with anything but a guarantee that the US will stop Iran, one way or the other and soon, that he will tell Obama that he will do it before the Nov elections. Obama will want any strike postponed given what his advisers have told him it could do to the economy, a better economy being his only chance of re-election.

If the Israelis do strike, more military observers now see a small chance that even the deeply buried facility – Fordow – could be taken out with some luck.  Still, Obama will stress even tougher sanctions and enhanced convert action at the meeting, and of course, more talks.

Some believe of course that the reason Obama has not armed the Syrian resistance is to appease the Iranians. Certainly the Saudis do.  They are likely correct, Obama waiting - even after the recent UN experience, being refused access to the Parchin complex - until after the Mar/2 Iranian “election” to resume talks (that, and they are not 100% sure just who they would be arming). Such support of the resistance may take place anyway but around the useless UN since Russia would veto.

We think the Iranians are bluffing for 1) goodies and 2) prestige in the region, with no intent to ever strike. Risk is if they get their choreography wrong, misjudge their timing.  That is the central point of concern we believe

Some obervers aren’t worried, like the CEO of France’s Total group, who says, “Let’s calm down,” reminding us that the Saudi’s have promised to make up for lost supply. But that mean’s practically nothing over the intermediate term, post strike, given the initial shock, and carry over, which would be enough to stall this economy (and put the E-Z in the sewer).

Others say either way, the lower costs of natural gas here will offset the all-in impact of higher gasoline.   Others, that supply constraints are not the same as last year same time, citing the Japanese supply chain disruptions.  These folk are the willfully blind.

Robert Craven

Set for Take Off, Unless....

Clients have known that jobs-related activity would broach estimates. In fact, it is just this activity which will fire much needed gains in hours and wages, thus gains in spending, 2012. Thursday’s Claims print fit our anchor – holding the new cycle low and reaffirming the sustainability of improvement in employment.

Other evidence has fit well, including a January survey of small business owners, where confidence hit a 4 yr high.  Many in fact are having trouble filling vacant positions for goodness sake.  The National Federation of Independent Business said its optimism index rose to 93.9 in January, the highest level since Dec 07 when the recession started. And it was the fifth straight month of gains.

So it is easy for economists to report now to their clients that job creation is improving. It was something else however to recognize that reality 4 months ago when the rest were looking elsewhere. We are not overly modest and so must admit we are rather pleased with this result.

There is a caveat however and that would be oil.  We had crude prices as tied to potential violence in the Mid East, as a wild card for several months.  It is no longer a wild card, but an event.
The translation of higher incomes to spending is then at risk for H1.

There is the temptation to apply the past to the future in building strategy. This exercise is easy, but it rarely works. Thus, the impact of higher crude prices last spring will not be the same as now.  This time we have a faster conversion speed, from crude to gasoline. Yet we have a consumer more resilient this time than last. So we must blend the two.

When that is done, our very early and rough estimate is for $4.50 / gallon average to shave retail activity by perhaps 0.2%.  Gasoline at $5 for any extended period will shave retail activity by 0.4%. Something significantly over that, for an extended period, will put GDP at zero, or worse.

According to the Oil Price Information Service, Americans spent 8.4% of their household income on gasoline last year when gasoline averaged $3.51 / gallon, an all-time high.  They will pay an even larger percentage this year is the guess of this organization’s chief oil analyst Tom Kloza, and this, notwithstanding the popularity of more efficient cars.  Thus, craziness from Iran can be enough to put us over the edge, to launch gasoline and stop the world’s number one engine, the US consumer, dead in its tracks.

Our view is that Iran wants nuclear as a tool to blackmail, not to incinerate; thus, she will always exaggerate the pace and potency of her program to gain concessions. The theocracy knows its days are numbered; it knows the next bit of domestic unrest may well be successful. So key is to remain in power by wringing all the concessions possible, then stop the belligerence just an hour or two before the Israelis take off.  Some of the masses will then be appeased by concessions gained; others will be fooled by Tyrant’s Rule #1 – when in trouble domestically, create an enemy offshore.

The real risk is that we will see gasoline at $4.50 - $5.00 over the intermediate term but not $8 which is possible, even likely given violence in that region.

Robert Craven

Win - Win for Iran (but a Brake for the rest)

We are all now aware of supply, and, conversion constraints on gasoline.  That is, gasoline typically rises in Mar and Apr each year as refiners switch the type they make. Summertime gasoline must have less butane and other cheap organic components because these criminals contribute to ozone (the ground-level type).  It means more oil is needed to produce each gallon.

We also know of supply considerations such as a strike in Yemen, a Syria pipeline explosion, shenanigans in Sudan, and the Iranian cut of to much of the EU and finally, some US refineries shutting for good.

According to the Oil Price Information Service, Americans spent 8.4% of their household income on gasoline last year when gasoline averaged $3.51 / gallon, an all-time high.  They will pay an even larger percentage this year is the guess of this organization’s chief oil analyst Tom Kloza, and this, notwithstanding the popularity of more efficient cars.  Thus, craziness from Iran can be enough to put us over the edge, to launch gasoline and stop the world’s number one engine, the US consumer, dead in its tracks.

Yet are they really crazy? Are the mullahs just plain nuts? No. They just want us to think they are.

For example, it was these guys for goodness sake who established the precedent that enemies cannot be allowed to have nuclear weapons. They were the first to recognize the importance of taking out an enemy’s nuclear facility and they were the first ones to try it – 1980, the Osirak facility in Iraq (a botched job and the Israelis finished it the next year).

 The Iranian thugs know that everybody else knows that they have enough natural gas for years of electrical-power; thus, they know that everybody else knows they are up to no good. And Iran is aware the West will indeed strike if pushed just a tad further, just as they themselves did 32 years ago. Thus, timing is key to them. They’ve got to get it just right.

Vic Hansen, a neighbor and one of the keenest observers of this region writes, “..the loonier and more suicidal it sounds, the more likely other countries are to grant concessions – successful states cannot afford to wager all that they have created on the likely hunch that a failed state like Iran is bluffing.”

Our view is that a strike on Israel is not their preference. They want nuclear to blackmail, not to incinerate; thus, they will always exaggerate the pace and potency of their program to gain concessions. Their government is a warped theocracy – an oxymoron to be sure – and knows its days are numbered; it knows the next bit of domestic unrest may well be successful. So key is to remain in power by wringing all the concessions possible, then stop the belligerence just an hour or two before the Israelis take off.  Some of the masses will then be appeased by concessions gained; others will be fooled by Tyrant’s Rule #1 – when in trouble domestically, create an enemy offshore.

But even if they miss their timing, even if they miscalculate and are bombed, they know that well over half the world will side with them, thinking they never intended a strike, noting the gross injustice inflicted by the Western bullies.

Thus if we are right then we will see gasoline at $4.50+ over the intermediate term, but not $8 which is possible, even likely given violence in that region.

Robert Craven

Oil - The Piano Overhead

The US economy will do quite well through H2.

There is however a significant wild card; that would be crude oil and the translation to gasoline prices over the intermediate term. This is the only potential retardant with enough potency to bring us to a sudden halt.

Every economist on Wall St has a nifty little model translating crude, and, or gasoline prices to economic activity. Because these models are rigid, fixed, because they do not account for consumer attitude at the time of energy price change, they rarely work.


Background:  Return to early 2011. Economists had just finished writing off Q4 ’10 activity when in fact it blew through estimates and came in at 2.3% (not strong in the literal sense, but that is not our point in this discussion).  Having been thus flattened, after dusting themselves off they rushed in the other direction, predicting great things for H1.

We wrote in early March that the Mid East (along with interventionist Fed policy) would act as a significant retardant and that H1 growth would come far inside of consensus.

When WTI printed 99 on Feb/23 (Libya) observers were not a bit worried. We said then that the course-of-least resistance for crude would remain higher over the intermediate term and that it would sap the consumer. By Mar/24, May WTI printed 106.69.  Still, Street observers remained in a trance, not shaving their estimates for GDP or consumption.

On Mar/26 we predicted a 120 high-side target, this tagged to potential Saudi / Iranian armed conflict. All the while, there were signs of slower consumption, but they went unnoticed by the willfully blind.

May/2 saw 114.65 on the near contract, WTI, the day after Bin Laden was killed. That was it.  Close enough to kick the legs out from under US momentum. With the translation to gasoline prices, and key – the sensationalist press that went with the Arab Spring, this and what had come before it was enough to stop consumption dead in its tracks. Retail sales collapsed Q2.

We could experience a repeat.  That is, we could experience a major slowdown in the US real sector; not for reasons now imagined, but for oil.

There is no guide and nor model to run to for help. We have to decide contemporaneously; every situation is different. Pressure on crude (much of it supply related, including a strike in Yemen, a Syria pipeline explosion, shenanigans in Sudan and the Iranian cut off to six EU states) represents the piano overhead for the US consumer.

Today we are paying $3.85 for gasoline on the west coast of the US and this just weeks before refineries typically shut down for springtime maintenance, just weeks before the states switch from their less expensive winter blends to more complicated and pricier summer blends. Feb crude prices are higher than they have ever been before on similar calendar dates, past years.  And we understand that a number of refineries were permanently closed in the last six months, refineries which represented the key to a smooth spring transition.  All of this means any higher crude will be translated to gasoline in a hurry, at warp speed.

Four dollar gasoline for even three weeks will slow the consumer; five dollars per gallon would stop the consumer dead in his tracks and put US growth at zero. And we could get there is a jiffy.  Iranian-birthed tension will intensify over the next few weeks, and that, thanks to an inept US administration. Obama is now trying to play catch up after his failed appeasement strategy. Now the sanctions finally have teeth. The EU has followed by pledging to stop imports from July 1.

Next, due to Obama’s hostility towards Israel we have much less idea what it may be up to, and much less influence than before.

Finally, the long-appeased Iranian theocracy is now more likely to miscalculate; thinking either that the confused Obama administration won’t stop it, or that any American attempt to stop it would be only half hearted. Hope resides in an uprising within the country, the masses feeling enough pain to throw out the troglodytes.  (They tried just that two years ago but were abandoned by the US.)  Short of such an outcome, violence is almost certain.

Robert Craven

Trading the Fed - An Update

We all know the Fed recently sent a beacon to the market crowd that the FF’s target will remain at rock bottom for a long while. We want to put that decision of telegraphing ultra low rates for three more years, to advantage.

One reason for the FF’s forecast is that most believe it; the other is that Bernanke is using this as a stealth tool in an effort to flatten the term structure.  The impact will be just the reverse.

Key is that the world market crowd takes Fed forecasts as gospel, as reality ahead. Thus, intended Fed generosity is priced in the Eurodollar strip. But we know conditions ahead will not cooperate; we know in fact that policy makers will change this forecast before most of them do.

Some are catching on, the Philly Fed’s Plosser and the Dallas Fed’s Fisher two of these. In fact, Fisher’s statement today the notion of another QE to be in the works is a “fantasy of Wall Street,” is very funny indeed. He is perhaps the most qualified of the bunch, but then neither he nor Plosser are voting this year.

Thus, we are keen for clients to own (L – S) the Euro strip.  We recently used Mar/12 – Mar/13 as an illustration, last 99.54 / 99.43, or -11. We had hoped for the opportunity to own the spread near even, early Feb, but no luck and such a window is not likely now.  Since course of least resistance for the Euro strip is wider over the intermediate term, look to own this or a similar spreads at or near present levels.  A reasonable target on Mar/12 – Mar/13 would be -25.

We want this trade on or something similar in anticipation of policy makers coming to understand, which indeed they will, that their earlier forecast was wrong.

Robert Craven

The Week in Review

The Jobless Claims series is as good a leading indicator as they come.  This series has served in that role since Q4 2008 when it began to recede from an all-time high. And Claims have been improving since last year’s Q2 soft spot. It is no coincidence that jobs-related activity has blown through expectations, Q1.

Thursday’s Claims print for the week ended Feb/4 fit our desk anchor nicely as the number of claimants fell 15M when observers expected no change. (We predicted in an earlier sketch that economists might even over estimate the strength of this release, correcting from past wide misses. That did not happen.)

Still, some note that since the pick up in production which prompted this decline in layoffs and spark in hiring was mostly to fill inventories, they fret that the earnings that go with more workers won’t be enough to clear the shelves, Q2. That is, companies may have gotten ahead of themselves. And finally, these types site consumer de-leveraging as another retardant to near term growth.  They are wrong on both counts.

Yes, consumption slowed a tad Q4, more than we expected, now only 6.5% above the year ago level. But it will gather momentum into Q2. To parrot modest earnings and hours from the latest BLS report is easy, but not key. What economists miss, as usual, is attitude, both for consumer and small business! There is no fear factor in this country (despite what consumers may tell pollsters). E-Z events are amusing, a distraction, but not a worry; consumers never heard of contagion, and wouldn’t care if they did. And we learned this week that to get set at the starting gate for Q1, consumer credit jumped in Dec/11, the 14th increase in the last 15 months.  

Next, in a recovery it is small business that contributes roughly 2 jobs for every one generated by large corporations. And we see obvious signs of a small business revival. Access to credit has improved as shown by the surge in banks’ commercial and industrial lending. And the index of capital expenditures intentions as measured by the National Federation of Independent Business, is climbing.

What we have seen this week then supports that advice extended to clients – US economic activity ahead will continue to flatten Wall Street estimates.  Our efforts at this center are designed to spare clients the necessity of having to react to the economic news; that is, we aim to prepare clients up front for significant changes to the contour of the economic landscape just ahead.

From Reuters this week: “A few months ago economists were all but certain that the US economy would slow sharply at the start of this year, with many warning that recession risks were growing. That pessimism has been shaken off by a string of surprisingly solid data that paint a picture of an economy building momentum.”

Clients were prepared for this reality and were thus in ownership of a long leg up on price discovery.

Robert Craven

Closing the Pattern

Our efforts at this center have one primary goal – that clients be spared the necessity of having to react to the news, that these clients are prepared up front for most major changes in the economic landscape ahead.

From Reuters this pm: “A few months ago economists were all but certain that the US economy would slow sharply at the start of this year, with many warning that recession risks were growing. That pessimism has been shaken off by a string of surprisingly solid data that paint a picture of an economy building momentum.”

Clients were prepared for this reality, thus owners of a long leg up on price discovery.


Robert Craven

Fed Intent and US Debt Prices Ahead

There are some that expect US debt prices to tank given an E-Z solution. No, this will not happen. Prices will easy the balance of Q1; the term structure will expand, balance of Q1, but there will nothing on the order of a jolt. This is because there is more to a low US rate structure than just the world wide flight to sanctuary.  That would be the translation of Fed intent.

For example, the Fed just sent a beacon to the market crowd that the FF’s target will remain at rock bottom for a long while. The mkt crowd takes that as gospel, and, assumes long rates will too.

Since Bernanke envisions a slow recovery that makes it a fact in the mind of his disciples.  The US won’t boom in 2012 naturally but will move a heck of a lot faster than the Fed understands it will. Thus, the congregation are about to be converted to crow bait.

We want to be careful that we don’t get rolled too.  Carcasses of traders who were right, but at the wrong time, are piled high. We always encourage our clients to discard the fluff. Listen carefully to what we have to say but then only work strategy at the margin, snipping a bit here and there on bouts of disappointment for example, building a position in that manner; never wholesale and never in a rush.

Robert Craven

The Week Ahead

The excitement behind us (Jan NFP, and the reported burst in January activity for the non-manufacturing sector), let’s decide how best to navigate the landscape just ahead.

First, a little something on crowd behavior:

Crowd dynamics apply equally well to that group of individuals known as street economists, those who through their collective estimate set market consensus, as they do to a revolutionary mob.  And like any mob or crowd - holding hands together, shouting out in the dark - they are prone to act 1) in unison and 2) in the extreme.

In times of uncertainty, opinions are drawn together. Past years we have observed that the greater the uncertainty the greater the similarity of predictions. This births vulnerability. That vulnerability or flaw as we prefer the term has been the near-consistent underestimation of real sector activity, past many weeks. Because of the buoyant Jan payroll print and the leading characteristics attributed to the release, that vulnerability has now reversed, at least for the near term.  All over Wall Street, old models litter the gutter. The market crowd was set up Q4, early Q1 to look for less than was there; they got rolled. Now the market crowd, at least for the near term, may be set up to look for more than is there.

We have a very shallow US release stream this week.  Only Claims Feb/9 may provide an illustration. Analysts don’t want to be flattened again, so as a group they will error to the side of less, not more on Claims.  We don’t think this example will illicit much reaction, but clients no doubt understand our point.  And it may better apply to the many key releases of the week of Feb/13.

And how does this translate to the bottom line? How might traders posture over the near term? Since we know that the US economy will continue to gain momentum over the intermediate term (short of wild card events) the trick then is to latch onto those bouts of “disappointment,” if and when, as windows to set trades by the way of FI, FX or equity. That is because these events will not represent trend.

We prefer spreads but to each his own.  Look to own the curve if not already long. Look to place option bear spreads on the note. Look perhaps at the equity sector too if that decision is based on macro considerations. Look at the Euro calendar spreads, which have move very little naturally as the market takes the Fed’s target as gospel.

But most importantly, do not, past day trading perhaps, set any trade based on intermediate to longer term US weakness, either in isolation or vs the E-Z  for example.  There will be the temptation.  Recall the “burst” in payrolls the spring of 2011, then the fade.  Many will prepare for a repeat, doubting sustainability. That period in 2011 however was accompanied by shocks of various sorts, primary among these – Arab Spring and the impact on gasoline, and, misdirected Fed policy and the impact on commodity prices.  And of course there will always be shocks, wild card events; Iran comes to mind. Aside from such an event, the US economy will continue to gain momentum.

Robert Craven

Week in Review

We heard that the dynamic of “surprising growth” for the US had lost its luster.

Those who performed this eulogy must now wince at the thought that to be published is to be found out.

After identifying relative vigor ahead early Q4 while most others were looking in the mirror, there was the risk early Q1 that our horse had played out, that insight provided through Q4 was no longer of much worth. But it was not to be.

Coming into Q1 clients were advised to rely on certain sectors of the US economy to deliver something through consensus.  Releases this past week were a satisfactory fit. Manufacturing was one of these and it cooperated. Consumer activity was another.  We expected a tad more from this sector, recent reads, but then Jan vehicle sales fit well.  We can expect a revival in consumer spending from the present pace, into Q2. Finally of course, jobs-related activity was another anchor.

The monthly Payroll print is not as important to economic reality ahead as the world market crowd makes it out to be.  It is key of course, just not the Holy Grail. The panic surrounding the release (and we have traded into over 150 of these in our career) is almost amusing. But it can also be quite deadly which is why we rarely come into these with outright exposure.

What can we fetch from today’s release, what leading characteristics?  For one, the strength in goods-producing hiring was impressive. And we can see confirmation of our anchor; that is, it is clear now that job creation is accelerating.  Over the past three months job creation has averaged 201M per month vs 133M the prior three months and 78M the three before that. However, we can also see from today’s print that there is nothing very impressive about earnings nor hours worked that go with these jobs.  They increased modestly. Oh well, can’t have it all.

What are clients to do now? Since we did not lift anchors set earlier, clients hopefully came through this week with one position or another set to profit from surprising US vigor.

For now, if equity oriented, look for the averages to expand, exactly as they have done from our first heads up, Oct/11.

If FI, know that course of last resistance for the term structure is wider; consider 5 – 10; try to capture some of this in the short end too with Euro calendar spreads, perhaps Mar/12 – Mar/13 because as we said earlier, the Fed is mistaken regarding their FF target. Resort also to perhaps the most versatile instrument of all; that is, look to place options spreads on the note, perhaps the bear put spread the most appropriate of the lot, the risk limited to the debit required to establish the spread.

Given the shenanigans of the E-Z types, execute only at the margin. If neutral into today’s release, don’t rush. Just know that fundamental developments ahead are to exceed estimates in spite of what it delivered from these clowns, and, that they don’t have to get all their problems fixed for us to do very well.

Wild cards remain in place, not the least of which is violence in the mid east – dismissed by most but as real as ever.

Robert Craven

Fed Policy and the Bottom Line

We have offered several recent specials in anticipation of the new Fed policy announced Jan/25.  We recommend that serious market observers review especially the sketches of Jan/5 and Jan/7 and that of Jan/26 to be found on the Hades site http://www.hadesresearch.com/.

We commend Bernanke’s journey to a world of transparency but since the Fed’s understanding of market dynamics is mediocre at best, the trip is freighted with risk.  Fed policy makers are economists.  Economists are trained to analyze.  Most cannot forecast.

Greenspan, one of the worst forecasters ever, understood policy making was seat-of-the-pants and did his best to hide that fact.  By his policy of openness Bernanke has made himself vulnerable.  We commend him for his courage, a commodity in short supply with Greenspan. Still, for Bernanke it will be a painful journey.

For example, 14 of the 17 policy makers expect FF’s to be unchanged at the end of the year and 11 at the end of 2013. This borders on the absurd.  But since this is from the market’s money god, it becomes reality; more, a certainty for most observers. Yet we know that the US real sector will deliver more than most expect, H1.  So we will have intended Fed generosity in the face of surprising vigor, which can only mean a steeper term structure. Policy makers will change course but not in time so this is exactly the impact we can expect. We are not interested in arguing with these people; we only want to convert their intent to the bottom line.

One individual who agrees with us is the Phily Fed's Pres Charley Plosser.  "Such statements are, in my mind, particularly problematic from a communications perspective," Plosser noted today. "Monetary policy should be contingent on the economic environment and not on the calendar."

Exactly so my friend.

Robert Craven