When I develop my monthly outlook for the markets, I usually have a theme. May’s theme was one of a trading affair, and watching the U.S. dollar. With the exception of crude oil, which went straight up, most futures markets did see trading ranges, without significant shifts in trend. In June, I still see this pattern continuing in many markets, but the theme no matter what you are trading this month is inflation—particularly in crude oil—and the measures policymakers may take to fight it.
After crude oil futures hit a record above $135 a barrel on May 22, 2008, there has been a push to place blame for the out-of-control prices (which some analysts, including myself, say are out of whack with fundamentals) on speculators, and pursue measures to check them. No question, rising crude oil prices are having a big global impact on businesses and consumers alike, and are taxing our economy.
This spring, we talked about economic slowdown and the possibility of recession, the impact of the dollar on the markets, and Federal Reserve’s interest rate cuts. Until now, it seemed Fed Chairman Ben Bernanke had been more concerned about economic contraction than inflation, slashing the Fed funds rate four times this year, to 2 percent by April 30. But in a speech since then, Bernanke signaled the Fed is likely finished cutting rates and is turning its focus on inflation-fighting. He said the “possibility that commodity prices will continue to rise is an important risk to the inflation forecast,” adding that “high headline inflation, if sustained, might lead the public to expect higher long-term inflation rates, an expectation that could ultimately become self-confirming.” Does this mean we have we dodged the bullet of recession? The jury may still be out, but at least the Fed seems to think so. Now, how do keep inflation in food and energy under control?
CFTC Investigates Crude Oil Prices
What’s making many commodities, namely crude oil, rise so quickly? Of course we have had the usual geopolitical factors here and there this year impacting crude oil prices, which we can see reflected as waves higher in the chart. From February to May 2008, crude oil moved from about $85 to $135, a gain of about 58 percent. That’s a pretty sizable move in just three months. Maybe we should’ve been more worried about inflation earlier.
After its peak on May 22, crude oil pulled back more than $10 amid mounting pressure to pin the blame for higher prices on someone, and figure out how to keep high crude oil from derailing global economic growth. The Commodity Futures Trading Commission recently announced that it has been investigating whether market manipulation has been overriding the traditional forces of supply and demand. If limits on positions pass, it will be very bearish for all markets. We will see an unwinding in many commodities, but I don’t think the CFTC will stun us and create price dislocations with a shock-type announcement. They’ll give the market plenty of notice, and time to adjust. But it’s certainly something to look out for if you trade.
Many on Capitol Hill (and in other nations too) are blaming speculators, particularly hedge funds and commodity index funds that have pumping cash into the markets. Testifying to the Senate, hedge fund manager George Soros said not only are we experiencing “the bursting of a housing bubble,” but at the same time, crude oil and other commodities have “some of the earmarks of a bubble.”
Billionaire hedge fund manager Boone Pickens also weighed in on the debate, but he contends crude oil prices reflect supply and demand. “You have 85 million barrels a day of oil available in the global energy market and 86.4 million barrels a day of demand. So the price of oil is going to go up until you can kill demand,” he said. Pickens predicted in April that crude oil would hit $150 a barrel this year, following Goldman Sach's predition in March that prices could rise as high as $200 in the not-so-distant future. Crude oil spiked back on June 6 after Morgan Stanely predicted $150 could come in a matter of a week, the way the market is moving. We can see in the chart how the market reacted to these kinds of forecasts.
The market also has also been reacting to efforts to talk the price down. The week of June 1, 2008, Bernanke said he’s now worried about inflation, which caused the market to pull back (as we see on the right side of the chart), and news of Congressional and CFTC investigations also set the market back in late May and the first few days in June. There’s talk that post-Olympics, demand from China will ebb, and prices will retreat. As oil prices increase, remember that corporate profits shrink due to increased transportation and related materials costs. That’s not good for consumers, who are becoming strapped. Buyers seem to keep coming back when crude oil drops back, but at some level, the economy is going to reject these prices. Maybe we are already seeing that happen. People will take the bus, will curtail their travel, or stay home instead of driving.
It seems to me people are trying to slow this runaway market down right now, although for the long-term, I think higher prices are here to stay. Even if crude oil drops back to $90, the trend is still bullish. Think about this; in 1999 crude oil was trading at about $10, so in eight years, this market has increased more than tenfold. Were we so far off in our forecasts that we couldn’t figure out global demand would increase? I can hardly believe it. I still think it’s important to watch the dollar this month, as a stronger dollar should also bring crude oil prices down. Policymakers (including Bernanke) have been trying to also calm inflation by talking up the dollar. For now, crude oil seems to have a mind of its own.
Do I think the bull market in commodities will continue? Absolutely. There are more participants in commodities than there were four or five years ago, and certainly 40 years ago, and I’m not sure they are going to go away. However, there will certainly be bouts of profit-taking along the way. I don’t think crude oil will hit $200 in 2008, but maybe in 2011. From a technical point of view, if crude oil closes under $120, I think we will see $111, a major breakout area, then $95. Then the bull market may be back up and running again. If you trade commodities, and are worried about a significant correction, worry about markets that have hit their all-time highs in the past or so, such as crude oil. Gold, for example, has already seen a notable correction from its peak of $1,000 an ounce in March, now trading under $900. Wheat is another example, peaking in March above $12 a bushel, and now under $8. Those markets may not fall out of bed as fast as others with more recent peaks, such as corn or crude oil. Keep in mind, however, the agricultural growing season is underway, so adverse weather conditions are likely to be overriding factors in corn or other crops, against these other concepts I’ve outlined.
S&P 500
What does this all mean for the stock market? While higher crude oil prices (and inflation generally) are not favorable to fueling a bull market, I do think the worst is over for stocks this year. We may see another significant correction this summer, but the year should end with losses in the single-digits for the major market averages, not double. That’s not so bad considering all we’ve seen—subprime issues, housing market decline, wreckage in the financial sector, threat of recession, and inflation.
From a technical point of view, I don’t see January’s low violated in S&P futures, near 1250, which marks a double-bottom. If we revisited that level, it would represent a loss of about 18 percent for the year, a pretty dire outcome. I can see the market pulling back to 1325, then rebound heading into the election. For this month, I think this market will be in a trading affair, but there is a lot of cash sitting on the sidelines, waiting for concrete signs the economy is improving. That being the case, we should see money moving out of Treasuries and other “safe-haven” type investments and into the stock market by year end. If you are position trader, I recommend buying major dips in stocks this month and next. Swing traders should stick to trading the range.
Feel free to call me to discuss trading strategies for these or other markets. Good luck and good trading!
Jeff Friedman is a Senior Market Strategist with Lind Plus. He can be reached at 866-231-7811 or via email at jfriedman@lind-waldock.com. Join Jeff for his monthly webinar, Friedman’s Futures Forecast, by visiting Lind-Waldock’s events page.
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