Here comes that bearish day feeling again, and soon the oil will be falling like rain. It always seems to be a Monday; leftover memories of Sunday, always spent with you until the clouds appeared and took away that bearish sunshine. What kind of mood are you in? Well sometimes that matters when you trade, yet what is more important is what mood the market is in.
Sometimes a market is in a bullish mood and sometimes the market is in a bearish mood. When it comes to oil, there's no market that is more moody. In fact sometimes it seems schizophrenic. Recently the mood of the market has been a major factor in success in trading it. Most of this year oil was in a bullish mood, and now, of course, we have seen a dramatic mood shift. Call it market psychology or call it what you wish. But whatever you call it, you have to realize that there is some significant change that has happened with the oil market. Oh sure, when you trade oil it is always important to know the fundamentals and what type of fundamentals the market is focused on.
For the first half of this year the oil market was mainly focused on the risk in the economy. There are some that will try to tell you that the surge in oil this year was a demand related phenomena. But if you look at the demand data, that was not the case. Oil rallied as demand fell; so it is obvious that the market had other issues on its mind. Sure, the market faced varying degree of geo-political risk factors. Because of the mood of the market, even those seemed to be blown out of proportion. It seemed any remotely bullish story set off a frenzy of buying; not necessarily because the story was that bullish. It picked away at the scab of the markets deeper fears about the health and stability of the larger economic world around us.
In this market's bullish mood, oil was being bought as a hedge against systemic risk in the economy. It was being bought as a hedge against the dollar but in larger terms it was being bought as a currency of last resort. No, the market did not wake up one day and suddenly endorse the theory of peak production oil, nor was it worried about tight supply. It was indeed worried about the entire US economic system.
Many argued that even if demand for oil slowed in the US it would not matter. They argued that the sub-prime crisis was just a US problem and would have little effect on the rest of the oil consuming world at large. That growth in Asia and Europe would carry the load and drive oil higher regardless of price. That mindset was evident in the bullish oil mood of the market as the dollar set record lows against the Euro.
But that mood has begun to change. People are realizing that the so called sub-prime crisis has not been contained. The sub-prime part of this is like ground zero in a nuclear bomb drop and the shock waves and fall-out from this crisis are expanding; not just across the US banking and credit system, but across the globe as well. Now the mood has changed, especially when it comes to Europe and China. Yesterday’s oil market movement was a perfect case in point for what the market is feeling.
At the last ECB meeting Euro bank President, Jean Claude Trichet, was feeling quite certain that growth was not the problem, but inflation was. Of course the markets took note of significant signs of the Euro zone economic slowing and oil and the dollar adjusted. The dollar soared as oil crashed in the biggest one month dollar value correction in the history of the oil market. This was the play that led us into yesterday’s session and was a perfect example of how the market was feeling; not only about the economy, but also about how it views geo-political and supply risk.
Yesterday oil was pulled in different directions. At first the focus was mainly on macro-economics. Oil rallied on short covering with other commodities as they awaited the big rate decision being handed down from the ECB. They knew that the ECB would keep rates unchanged. But would they be more paranoid about the risk for inflation like they had been; or would they acknowledge the risks of slowing economies? Would the ECB acknowledge what the market knows that the ECB is starting to slow?
Well, to Euro banker Jean Claude, I hate to say ‘I told you so’ but maybe Ben Bernanke will. The ECB must face up to the fact that growth is indeed slowing and that they too may have some credit issues of their own. That does not make the US look better, but at least Bernanke realized earlier on the depth of this financial crisis. The ECB and Jean-Claude Trichet warned that euro zone growth will weaken substantially this year even though inflation will remain above the ECB target rate. In other words, Ben Bernanke was right when he warned the EU about the issues surrounding the dollar and the Euro zone economy. Reuter’s news reports said the deteriorating economic outlook is prompting Euro-zone banks to toughen lending standards for households and firms. Reuters continued that the ECB's latest quarterly report on bank lending showed banks made it harder to borrow money in the second quarter of 2008 and expected to raise the barriers further in the months ahead.
Bad news in Europe is good news for the dollar and bearish for commodities. Still oil had the geo-political arena to worry about. Oil transcended the other commodity markets for a while when questions arose about the explosion of the Baku-Tbilisi-Ceyhan pipeline (sometimes abbreviated as BTC pipeline). It runs about 1.0 million barrels a day and can pump slightly more than 1.0 million barrels according to the AP; which is more than 1% of the world's daily crude output. It is the second longest oil pipeline in the world after the Druzhba pipeline. The oil market rallied on conflicting reports as to how long this pipeline might be down and how the pipeline actually exploded.
The market's worst fears were confirmed when a Kurdish separatist group called Kurdistan Workers' Party, or the PKK, took credit for sabotaging the pipeline. The PKK is a known group that has threatened to blow up pipelines in the past. Oil had to price in that threat even as the macro picture changed just a bit. The market wanted to break but it had a hard time.
Even with that slowing demand, oil is having a hard time staying higher even with these increased threats. The markets are more focused on the dollar and its new found strength. Oil is less looking at geo-political risk and slowing demand risk. A few weeks ago when the market’s mood was bullish, oil would have soared on that pipeline news. But supply worries have less impact when the focus and the mood are based on slowing demand.
Therefore, the good news is gasoline prices will fall further. AAA reported that gas fell over a penny to $3.849. That is more than 6 percent off record-highs above $4.00 a gallon reached last month!
Even Iran news is not moving energy as much even as the five permanent U.N. Security Council members and Germany agreed Wednesday to pursue new sanctions against Iran. Condi Rice says the clock is running out but so too is the clock on the oil bulls. Oil is unmoved even with rumors of the US sending aircraft carriers to the gulf, and with more reports of Russian planes on the attack in Georgia. When the mood shifts, the bulls will get that rainy day feeling again.
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