Reasons for Lower Oil Prices

Americans are about to let out a big cheer because pretty soon gas at the pump should be a lot cheaper. Oil as measured by the S&P GSCI Crude Oil Index is down over 7% today! Since its peak on May 2^nd it is 21% lower. Now who says that there wasn’t a risk premium attributable to Osama bin Laden? (I believe it was just a coincidence that oil peaked the same day the Navy Seals took him out).

The amazing thing is that Americans are just satisfied that gasoline prices at the pump are heading lower. No one seems to be questioning the rate of decline. We should be outraged! Since the National average for regular gas hit close to $4 per gallon in early May, it should be around $3.16 today. However it is significantly higher than that.

Don’t give me this mega oil industry jargon about lag time for prices, crack spreads, and summer blending issues, because when the price of oil was rising the gas stations were raising their prices daily just to keep up. The rate of change should follow price in both directions.

So why are prices declining? Aren’t there multiple protests and even war zones in several of the oil producing countries? Apparently that does not outweigh the slowing rate of growth for the global economy.

Domestically all of the economic reports for the last few months point to a slowdown or in some cases a return to negative growth. Clearly the US housing market has slipped into double dip territory with prices lower today than at any point in the recovery.

The fears of inflation due to rising food and energy prices may soon get knocked off by a rising fear of deflation. Governments are continuing their attempt to stave off defaults around the globe due to lack of economic growth. Food prices may remain high as production factors, weather, and a growing global population put a crimp into supplies.

Fear is starting to grip investors and for good cause. Institutions are in sell mode. This is very evident when looking at the trading volume on down days versus the market’s rally day volumes.

Apparently investors like bailouts and other socialistic government interventionist programs that attempt to prop up markets. Collectively investors are hoping for a Greek bailout package to be put together this weekend so we can “kick the can down the road” once again.

Higher taxes and stringent austerity programs are not going to create growth for Greece. All a bailout is doing is delaying the inevitable. However as long as a Greek default is not today’s problem, it seems investors will be satisfied even though it is clear they don’t have enough money to meet their current obligations. Apparently that is just a minor detail.

Oil prices are falling – fast. Aggressive investors can capitalize by buying into the ProShares UltraShort Crude Oil ETF (SCO). SCO broke above its recent base today when it cleared $49.49. The price target for SCO applying some technical analysis techniques is $63 to a $66 per share.

Fundamentally, if the problems in the oil producing regions do not spread any further oil prices could decline. In addition should our economy continue to slog along with slow or no growth, this trade to make sense for today’s investors.

SCO is a two time leveraged inverse fund, so it is not for the faint of heart. It will move at a rate that is twice as fast in the opposite direction of oil prices as measured by the Dow Jones- UBS Crude Oil Sub-Index. Over time leveraged funds do not track an exact inverse rate – but it will move!

SCO was at $51at the time of publication. Use $44.50 as an exit point should oil prices begin to rise again and the economy begin to accelerate.

Reasons to Cheer

This week markets closed almost flat on the week depending on which index you review. Prospects for a Greek bailout package getting approved and fast falling oil prices should give investors a reason to cheer next week. Find out more by tuning into Money Talks today!

Click on this link to listen to this week's market comments: http://yourmoneytalks.podbean.com/2011/06/17/reasons-to-cheer/

Bullish or Bearish?

The major market indices are all down around three percent for the month of May which coincides with the amount they are off from their recent recovery highs. As a percentage that really is not a lot to be concerned about.

However a review of the most recent economic data, the picture gets a little fuzzy. A few weeks back was the ISM Services report plunged from 57.3 to 52.8. Anything over 50 demonstrates growth, but the consensus was for an improvement to 57.8 and this obviously indicates we are heading in the opposite direction. It is important to note that 80% of our economy is dependent on the services sector.

On the manufacturing side of the ledger the situation actually looks even worse. The Empire State Manufacturing Index, the Philadelphia Fed Manufacturing, and Durable Goods Orders all came in the last couple weeks at their lowest levels in many months. It clearly indicates that the rate of the economic recovery is shrinking and unless something changes, could fall into negative territory.

The Conference Board’s Index of Leading Economic Indicators reported its first negative reading in nine months falling to a negative 0.3% for April. The much anticipated upward revision for first quarter GDP fizzled as it stayed at an unimpressive 1.8% this week. That is down from the 3.1% GDP growth reported for the fourth quarter of last year.

Meanwhile housing remains at depressed levels as prices continue to fall and sales of both new and existing homes are down in the double digit levels from a year ago. This occurred while the economy was actually getting stronger.

Emerging market and the so called BRIC countries (Brazil, Russia, India, and China) are all down more than our markets which is causing some concerns among investors as many thought that the BRIC’s would lead the global recovery this year. With commodities off as much as they are many of these resource rich nations have fallen hard.

Still encouraging the bulls is the fact that the Fed’s Quantitative Easing Program still has a month to go. It doesn’t hurt stocks that the Fed kicked in an extra $31 Billion in the last five days to the Primary Broker Dealers to do with as they please. Rumors that another round of Quantitative Easing may occur also helped juice the markets in the last couple of days. At the very least the bad economic reports lately are pacifying all concerns about an interest rate hike coming anytime soon.

Markets had also reached oversold levels this week and were due for a bounce. How big that bounce turns out to be remains the big question. On a technical level markets paint two opposing pictures. On one hand a breakdown of the uptrend from the March 16^th low has occurred – which is negative.

However another obvious pattern in the charts is that of a flag formation. Flags generally fly at half mast. This means that there is likely a case for the markets to break out of the downward flag slope and most likely rise to even higher highs for the year.

It must be noted that the Dow has been down the last six years in a row in the month of June. However, there is a high propensity for markets to rise going into three day Holiday weekends. Plus the end of the month may give the bulls some strength. So is the current market bullish or bearish? Time will tell.

The Debt Problem

Monday before the market opened, Standard and Poor’s reaffirmed the U.S. government's top credit rating of AAA but not before expressing concern that our legislators are not move quickly enough to stop our growing budget deficit. S&P said there is a 33 percent chance it would lower the country's credit rating from AAA in the next two years if Washington fails act.

U.S. Treasury Bonds have historically been known as the safest investments on the planet. But now top money managers such as Pimco’s Bill Gross are calling our debt issuance a Ponzi scheme, where one arm of the government – the Federal Reserve Bank, is supporting the US Treasury, by buying as much as 70% of the new debt that has been issued since last September.

Many pundits are stating that this move by the ratings agency to lower its outlook for U.S. paper from "stable" to "negative" caught investors off guard. While this is a first since it began rating the creditworthiness of government bonds back in 1860, this action should hardly be a surprise. Our debt has skyrocketed over the last few years to levels only achieved during major wars.

Today the total outstanding public debt in the US is around $14 Trillion. The debt to GDP ratio is among the highest in the world. The federal deficit has approached this echelon only a few times in US history; during the Civil War, World War I, World War II, and today in aftermath of the financial crisis of 2008.

Should our government debt get downgraded in the future, we would have to pay a higher interest rate to attract new buyers. More problems would occur, as many institutions are banned from holding anything but AAA rated investments. That would force a sale of their holdings, which would result in lower prices and even higher interest rates.

As troubling as this may be for the US, the situation in parts of Europe are even more problematic. Greece and Ireland have already needed to be bailed out by the IMF and other Euro zone countries and are still reeling. Both countries have had their credit rating downgraded again in the last month.

Portugal is now and need of a bailout. Also there is speculation that Spain and Italy will need help in the near future. Should Spain require a bailout, it is estimated that the money needed would amount to the sum of all three of the previous countries combined. It can be surmised that as bad as the situation is over here with our current debt warnings, the problems are even bigger in Europe.

The Dollar Destruction

As infamous trader Jesse Livermore used to say, “Conditions are ripe for a sell off.” The litany of global problems that exist seem to be compounding every day. As if the market doesn’t care, the major indexes have spiked up over the last few weeks. It does seem odd to see such strength under these circumstances.

This week however, trading started off the day quite positive but then gave back much of it by the close. Strength in the morning followed by weakness in the afternoon is usually a bearish sign. While the S&P 500 has been up three of the last four days, we‘ve had only a fractional gain this week.

Usually the start of each month and especially the start of a new quarter is a time for strength as retirement plans of every ilk get funded and new money flows into the market. With April’s monthly strength period now over, hardly a dent has been made towards a market advance.

The strong season for the market is also coming to a close. There is historical statistical evidence that gives credence to the “sell in May and go away” concept for period investing. While markets don’t have a calendar, the November through April timeframe historically has significantly outperformed the May through October period, and May is coming soon.

Investor sentiment is running high. The recent Investors Intelligence Sentiment Survey reveals that less than 16% of professional newsletter writers are bearish and over 57% are bullish. This Bull to Bear ratio of 3.65 displays even more optimism than at the market peak in 2007.

This survey has been widely adopted by the investment community as a contrarian indicator. Since its inception in 1963, the indicator has had a consistent record for predicting the major market turning points.

Another contributing worrisome factor is the coming end of the Fed’s Quantitative Easing Program (QE2). When the Fed stops buying bonds, monetizing our debt, and pumping billions of new dollars into our economy on a daily basis, how will the markets fare? That is a big question. Currently it’s as if the economy is cycling ahead with training wheels on. What happens when they come off?

Should markets correct on anticipation of or at the end of the QE2 money pumping machine, it would mean that a market top was occurring at almost precisely the same time it did last year, which included the Flash Crash.

One of the key factors that markets appear to be ignoring today is the ever rising price of oil. High oil prices have always led to a recession. Oil is a direct reflection of a falling dollar. With the ongoing destruction of the US dollar, caused in a large part by the QE2 program, commodity prices are going through the roof. Now is a time for caution.

The New Era

Many believe that the old saying, “it’s different this time” is never true. It is widely held that situations are never completely different; they’re just another version of events with slightly divergent circumstances. History may not repeat, but it sure rhymes, is another old saw bantered about Wall Street.

It is believed that the reason market events repeat generation after generation is that human emotions of greed and fear has always been and always will be present when it comes to money and investing. Today’s technological advances may create a contradiction to those old beliefs. It has made life simultaneously simpler and more complex, and has brought an element of change that hasn’t been present in the past.

Use Major League Baseball as an example. Baseball hit upon a new era with the development of steroids and human growth hormones. Old pitchers well past their prime became Cy Young award winners. Not just one but two players broke a 40 year old home run record in the same season, only to be surpassed again within a couple of seasons.

It became known as “the steroid era.” It truly was different. Fans were enthralled at the new found power of the times. They cheered along, but the Commissioner had to know that something was up. Those feats of athleticism had never been witnessed before, but the baseball brass stayed mum because ticket sales and TV revenues were doing great.

Now many fans are shocked to find out that the game was rigged by players’ use of steroids. They must have figured that players were just eating better and working out more. But no – things were different.

Today the Fed has done the same thing. They have created a new era. They have put the money printing press on steroids. Since August, the Fed has bought 70 percent of all the new government debt issued by our Treasury. The Fed is in effect monetizing our debt and creating an artificial stimulus for the economy. Fed Chair Ben Bernanke hopes that this crutch will be enough to create confidence among consumers to become a self fulfilling recovery.

Some very well known bond managers are not so sure this new era will work. Pimco’s Bill Gross calls the Fed’s path a Ponzi scheme. Gross believes that everything the Fed is currently doing will prove to be harmful in the long run.

Investors, like baseball fans in the steroid era, are currently very happy. We just had the best first quarter returns since 1999. Since the market was actually negative for the year on March 16th, if the media really called it correctly, it’s been a good couple of weeks! The commissioner (in this case the Fed Chair) is participating in the juicing of the game so to speak. At some point all this will come to a tragic end, but for now it’s just “Play Ball!”

The Luck of the Irish

In today’s feature the “Luck of the Irish” will hopefully mean that we can make some green (as in backs) from today’s trading strategy. The markets have been more volatile in both price and volume lately, for good reason. Geopolitical events in the Middle East and North Africa are becoming more widespread. The Japanese crisis is more uncertain with each passing day.

On a technical basis, all the major market indices appear to have broken their up trends and recent support levels. Because markets rose at such a fast past since the beginning of September, there is very little support between here and their respective 200 day moving averages. This could mean there is more downside to go before reaching next support.

There is a lot riding on the depth and duration of this correction. The primary reason the rally started was that traders felt that the Fed had their backs in a sense. As Ben Bernanke outlined his Second Quantitative Easing Strategy (QE2), many traders did a little math and recognized that $4 to $5 Billion of new money was going to move from the Central Bank to Primary Broker Dealers on a daily basis for the next nine months.

The Fed monetizing debt, while simultaneously pumping banks with a plethora of cash, gave a level of comfort to traders that the stock market would be a one way street up. Until mid February, that has been true. The VIX “fear index” dropped below levels of complacency not seen since before the 2007 Great Recession began. Optimism among both institutional and individual investors held bull to bear ratios at extreme levels for extended periods.

It almost felt like the golden age of investing was back, as the “mom and pop” investors who missed the double off the bottom over the last 20 plus months started to come roaring back in. Now that the belief that the Fed can print our way into prosperity is coming into question, a vacuum of confidence could occur.

In the near term it appears that the market has more downside to go as support has been violated. Using one of the oldest and most actively traded ETF’s the SPDR S&P 500 (SPY) to create a synthetic short position by Selling an April 125 Call for $4.24 and Buying an April 125 Put for $3.37 per contract could be profitable in this environment. In this example you start by pocketing $87 per contract immediately.

A couple of technical analysis methods point to SPY having a near term price target of $119. Two reasons: First, that is where its 200 day moving average is. Second, this run started at the end of August with SPY trading at $104.29. It reached a high on February 18th of $134.69. A normal 50% Fibonacci retracement puts SPY at $119.49.

Should this happen in a week’s time this trade could result in a profit of approximately $650 per contract. The risk comes into play should the market move up quickly. SPY closed yesterday at $126.18. Should SPY trade here or lower this will be a good trade.

If you currently own shares of SPY, employing the same strategy creates a collar on your position and is an even lower risk trade should the market recover as your exposure is limited, but so is your return.

There are many reasons to believe that the market could continue in its downward trajectory. Not only are markets ripe for a pullback, should it start to accelerate down, a generation of investors will be lost as they throw in the towel quickly and the confidence of even most astute investors could be shaken. If that happens SPY could overshoot $119 making this recommendation even more profitable.