Monday, June 13, 2011

Oil is power...but power is not Oil

These charts reinforce that the dollar rally is NOT a bounce in a bear market move but potentially the start of a powerful and sustained rally. There are clear reasons that the Saudi chart looks like it does and there are clear reasons that the implications of the implied move in the markets and oil should be expected and understood. Its not going to be pretty...but to me this scenario is going to play out and while I have tremendous respect for Jim Rogers, I believe that the exponential curve is going to take care of commodities and that the expungement of hidden and obfuscated insolvency especially in the derivatives markets and banking system will curtail pricing power and inflation in all asset markets. I do not believe that holding your purchasing power via commodities is the most optimal way to play out what has been occurring in the commodities markets...but please remember Goldman Tax is promoting long oil and other commodities to their clients, which likely means that they are bad trades as we can see by their horrible oil and copper trade so far...and its going to get MUCH worse.


Initially, when I started watching these charts, I was struck by the clear patterns that also coincided with my systems consistently biasing short for the last 7 months for swing trades. The reality is that during that time the systems have won nearly every trade they have taken and have had an abundance of double digit return months. However, I was left wondering about the curious setups and discordant behavior I have been watch that suggests cataclysmic price movements ahead. Curiously, the charts below support two observations...a very strong and persistent rally in the dollar and that the next version of the 2008 catastrophe will not be banks but centered around energy and sovereign nations. Another irony is that the impending energy market blow up has been christened with the catastrophe at Fukushima.

Bubble Mechanics, tall buildings and ski slopes in the desert

In the late 1990's Saudi Arabia had a break-even of less than $10 per barrel, in 2003 it increased to the low $30 range, by 2009 to 2010, break-even rose to the $50's and the 2011 break-even now is over $90 per barrel. Additionally, the 2011 break-even for Bahrain, Oman, U.A.E, Qatar and Kuwait has more than doubled on average, from 2003 levels.

I think we can all remember the Dotcom phenomenon...a time in which people from all levels kept seeing and forecasting higher and higher prices while at the same time similarly increasing their spending and personal and corporate break-even's. The reality is that in the middle east they have built the tallest buildings, temporary man made islands and temporary indoor ski slopes...not satsified with mania such as that, they have been working very hard to monetize and leverage nearly the entire margin possible from their only real asset "oil" so that they can support on-going and rapidly expanding government spending and malinvestment.

Rising costs for oil producers is widely credited as being the reason that prices will not drop. However, I believe that one could use that same logic in the recent Silver bubble that is currently bursting and the dotcom, technology and housing bubbles.

We are now left with the weary and tired commodity and energy bubble. Quite simply, the argument that large investors can leverage themselves to the teeth and somehow collude to keep prices up, thereby propping up their bubble ad infinitum, is ridiculous. Long-term capital management, Soros and the pound the banks and their CDO's, CDS and structured products all have become targets of scarce liquitity and well funded adversaries who can easily blow apart a widely known trade or financial weakness or incongruity. The financial anomaly in sovereign oil producing nations does not stand much chance either.

Anyone stupid enough to push their break-even to $90 (let alone has the gaul to predict break-even next year at $110) with oil prices currently at $95...deserves what they this case total financial annihilation. Moreover, the sovereign's have another problem, they mistakenly believed that oil passing the peak of the exponential bell curve meant scarcity of supply could drive infinite price appreciation. They are clearly wrong, just as the silver bugs preached a similar peak silver was misguided and is being proved wrong. There are some differences, however, to normal debacles in that oil producing nations will attempt to further curtail supply to prop up prices...this approach will likely fail due to their and everyone else's pending insolvency...the dollar will make it impossible for their scarcity and peak oil argument to work...there surely will be other influences like other producers who can actually get oil out of the ground for less than 90 dollars a barrel...but, regarless of losses, the sovereign's will need to continue to sell oil at those huge losses in order to obfuscate their financial insolvency for as long as conceivably possible. In the end, there will be a competition for who can sell the most oil first as the rush for cash spreads. Their plans will not work terribly well and by the looks of things the indoor desert ski slope.

So, the result of all this is that regardless of a dollar move to the upside, the sovereign oil producing nations are in deep trouble and insolvent. With the dollar rally, prices for the many commodities including oil are in for a very significant decline. These markets will be driven a similar issue - the need to covert a non-cash asset into cash.

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