Please, click here to read this article in pdf format: february-25-2011 It’s the end of the month and the animal spirits nervously want to take profits on a good February. Before we start today’s letter, we want to clarify our view with respect to the impact of the developments in the Middle East on the [...]
Please, click here to read this article in pdf format: february-25-2011
It’s the end of the month and the animal spirits nervously want to take profits on a good February. Before we start today’s letter, we want to clarify our view with respect to the impact of the developments in the Middle East on the price of oil. When we wrote that: “…A shift towards democracy in Egypt and the rest of the Middle East is bearish for oil…” we were clearly speaking of the long-term, on the assumption that chaos is followed by democratic (At least formally) governments. That time is far, far away and right now, we have chaos. But if democracy is established in the Middle East in the 2010’s, just like it was in Latin America in the ‘80s, we expect the OPEC to slowly become irrelevant, as the new political class of those countries desperately depletes any source of cash it can lay its hands on to win votes.
Yesterday, was a day full of inconsistencies, in our view. Gold had been testing the $1,418/oz level by the time the weekly jobless claims print was released at 8:30am. Post the announcement, which was bullish (22k less, to 391k), weakness in gold began. This was the first inconsistency, for a stronger job market means to us, all other things equal, a higher probability of seeing a pick-up in CPI (consumer price index) earlier. Yet, the release must have been interpreted as bullish for stocks and a reallocation trade could have been triggered.
The other nonsense we heard and read was that the S&P/TSX Global Gold Index sold off with oil. This is simply not true. The index opened the session selling off, even with the price of WTI above $99/bl. This weakness in mining stocks was immediately followed by weakness in energy stocks (here, we refer to the S&P TSX 60 Capped Energy Index). It was early in the day and both gold and oil were stable. Yet, their “derivatives” were on the downside. While stocks and credit were deciding which way to go, the confusion was enough to push us out to the sidelines, after a great February. And that proved wise, for the rest is history…
What triggered this sell-off? If anything, the developments out of Libya would suggest a higher price for oil, as we understand that it represents a loss at over 1 to 1.2 million barrels/day. We also don’t think the sell-off would have been driven by a liquidity stress, for nothing of the sort was reflected in the credit or rate markets, in our view. We think the explanation lies in the strength of the Euro.
As we write, the Euro is trading above 1.38 USD, in spite of all the noise coming out of Ireland (elections today!) and Spain (recent 1.5% increase in minimum wage). The strength is explained by the hawkish messages that have been coming out of the European Central Bank lately and, if we may add, the total absence of clarity on where the European Financial Stability Facility will end. The higher Euro, via higher rates, is simply recessive and it will push Greece and others to restructure or default sooner than later. This, in addition to the folly of the new regulations on bank capital, is the sort of things that may end up in a run against a country’s financial system on a gray Monday morning…This is the sort of thing that could explain bearishness in gold, oil and stocks simultaneously, for the sake of bearishness, in spite of a $600bn quantitative easing program, strong earnings, lower jobless claims, etc. etc.
We are not saying that the strong Euro caused the yesterday’s action. We cannot prove causality here (at least not us). What we are saying is that this explanation is more consistent than any other we’ve come across, and we like it because it means that someone out there knows something we don’t know, which is proof enough, if we follow Occam’s razor principle. On this note, we take this weekend off, preferring to remain on the sidelines until the ECB meeting, scheduled for March 3rd.