Archive for March, 2009
Chart Reading: USD Chart Analysis
US Dollar (3/26/2009)
S&P 500 (3/26/2009)
Spot Crude Oil (3/26/2009)
Strong US dollar seem to be correlated perfectly with poor stock market, crude oil prices. In a way that it’s almost perfect timing that US dollar peaked on the day in early March when S&P 500 hit an 12 year low and reversed track. It’s almost on the same day when crude price started to break out for real, it tried to break out several times in last 3 months, but turned back at resistance line.
It’s not illogical for this relationship: if the real production is not increased significantly, the only way to make people rich is to print out more paper money, and each unit of paper money has to depreciate more to sustain the “wealth making”, “crisis prevention”, “bail-out”, whatever you call it.
One thing is for sure, when USD starts to depreciate, and especially when government is behind this trend, it’s time to spend your cash to buy some stocks, gold, energy. For investors in stocks, this is great, let’s hope USD to depreciate more.
4/24/2009 Update:
US Dollar (4/24/2009)
S&P 500 (4/24/2009)
Spot Crude Oil (4/24/2009)
The S&P is now going thru the right shoulder of reverse head and shoulder bottoming process, and USD is doing the right shoulder before the huge crash which I estimate to start around July. So the chart indicates there will be still an small up-leg left for USD.
Even though there is a rough relationship between $USD and equity, commodity prices, what’s most interesting was the relevance between these market forces changed over time. Let’s take a look back at history:
From mid July to early September, $USD started to rally, in the mean time, stock market started to look like about to fall off cliff. Crude oil started to drop from historical high of $147. This is the prelude of the huge crash. During this time, only dollar-oil relationship worked.
From early to late September, $USD pulled back, in the mean time, stock market didn’t respond to that pullback, Crude oil did. This time, only dollar-oil relationship worked.
From late September to mid October, $USD resumed its rally, this time with stronger force than last time, reflecting the real crash had begun, we all know what happens to stock market and crude oil. During this time, both dollar-stock and dollar-oil relationships worked.
From mid October to mid November, $USD continued its rally, but with weaker force, stock market mirrored that movement, but crude oil continued its free fall. During this time, I would say both relationships worked, but dollar-stock seemed to dance better than dollar-oil.
From mid November to mid December, $USD crashed due to Fed’s dropping rate to 0, stock market responded, cruded oil kept dropping despite a small rebound in early December. During this time, dollar-stock relationship is again bettern than dollar-oil.
From mid December to early March, $USD staged a strong come back, this time rallied higher than the peak reached in November, stock market responded, crude oil didn’t, instead, crude oil reached its bottom exactly when $USD started this round of rally. Remember at this time, Shanghai stock index started to rebound. So shall we say this time, crude oil wishes more to dance with Chinese stock index than with US Dollar?
From early March to mid March, $USD crashed again due to Fed’s decision to print more money to buy T-bond and MBS, stock market responded, crude oil responded as well. During this time, dollar-stock and dollar-oil both worked again. Last time, both relationships worked was late September to mid October.
From mid March to now, $USD rebounded with a wedge shape (a precursor to huge crash), stock market shrugged it off, continued its rebound to the heavy resistance of 870, while crude oil traded sideways. During this time, let’s say both stock market and crude oil are getting ready for the huge crash of dollar.
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Invest in Oil: How to Buy Crude Oil at Spot Price?
Most energy investors need to invest in oil, but it’s impossible for average investor to buy and hold physical crude oil, and then sell it later, it’s simply too difficult. To address this problem, many investment vehicles have been created to facilitate investing in crude oil. This post talks about each of the major oil investment vehicles and their relationship to crude oil price.
Oil Prices
The often talked about oil price is not a price of a single product, but have at least two versions: spot price and futures price. Among spot price, there are two versions as well: West Texas Intermediate (WTI) Spot and Brent Spot, and WTI price is more widely used in US.
Oil ETF and ETN
Several Exchange Traded Funds were created to reflect crude oil prices, either spot or futures, so that investors can invest into this important component of commodity.
In fact, these securities are not real-sense exchange traded funds, because ETFs are supposed to hold the physical assets such as equity or commodity as underlying assets, but given the difficulty holding crude oil physically across the time, these ETFs buy and sell futures to track oil prices.
Contango and Backwardation
This way of working actually makes the price of these ETFs more complicated, the shape of futures price curve can actually affect their prices, there are two types of futures price curves: when earlier maturity futures price is lower than than later maturing futures price, it’s contango and the contrary is backwardation. Read here to learn more about contango and USO, and here about general concept of contango and backwardation.
Here is a perfect explanation of contango and backwardation from this article:
Backwardation in the crude oil futures market typically indicates that oil market fundamentals are tight, but should ease in coming months. For example, after Hurricanes Katrina and Rita, near-month crude oil futures spiked as traders fretted over supply disruptions in the Gulf and damage to refining and transport infrastructure. There were some temporary shortages of crude and gasoline in certain markets because of pipeline and refinery closures.
At the same time, most traders expected conditions to ease once pipelines were inspected and brought back online. Thus, near month futures traded at high levels relative to longer term futures–the market was in backwardation.
Contango implies that near-term oil market fundamentals are bearish but investors still expect longer-term improvement. In the late 2008 through early 2009, investors faced rapidly rising US oil inventories and an accelerating decline in global oil demand–fundamentals looked bearish.
More important, the US and global credit markets were in a state of near-total dysfunction. The lack of demand, excess supply and near cessation of business activity due to weak credit market conditions pushed down near-month futures and sent contango to record levels.
Since early this year, contango in crude oil futures markets has declined to around USD8 a barrel, still a historically stretched level. The simple recovery in contango to more normal levels accounts for about USD27 a barrel of the USD31 a barrel rally in spot prices since the beginning of the year.
With these in mind, here I give crude oil ETF and ETN a comparison.
US Oil Fund (USO)
USO portfolio: The portfolio will consist of listed crude oil futures contracts and other oil related futures, forwards, and swap contracts. USO will also invest in obligations of the United States government with remaining maturities of two years or less and hold cash and cash equivalents to be used to meet its current or potential margin or collateral requirements with respect to its investments in crude oil futures contracts and other oil interests.
USO Market Cap: $4.47 B (as of Mar. 25 2009)
USO Average Daily Volume: 34.16M
iPath S&P GSCI Crude Oil Total Return ETN (OIL)
OIL ETN: iPath Exchange Traded Notes (ETN) are senior, unsubordinated, unsecured debt securities issued by Barclays Bank PLC that are linked to total returns of market index. The iPath S&P GSCI™ Crude Oil Total Return Index ETN is a sub-index of the S&P GSCI™ Commodity Index. The S&P GSCI™ Crude Oil Total Return Index reflects the returns that are potentially available through an unleveraged investment in the West Texas Intermediate (WTI) crude oil futures contract plus the Treasury Bill rate of interest that could be earned on funds committed to the trading of the underlying contracts.
OIL Market Cap: $777.53M
OIL Average Daily Volume: 3.71M
PowerShares DB Crude Oil Double Long ETN (DXO)
DXO ETN: All of the PowerShares DB Crude Oil ETNs are based on a total return version of the Deutsche Bank Liquid Commodity Index-Oil (the “Index”) which is designed to reflect the performance of certain crude oil futures contracts plus the returns from investing in 3 month United States Treasury bills. The Long and Double Long ETNs are based on the Optimum Yield™ version of the Index and the Short and Double Short ETNs are based on the standard version of the Index. The Optimum Yield™ version of the index attempts to minimize the negative effects of contango and maximize the positive effects of backwardation by applying flexible roll rules to pick a new futures contract when a contract expires. The standard version of the index, which does not attempt to minimize the negative effects of contango and maximize the positive effects of backwardation, uses static roll rules that dictate that an expiring futures contract must be replaced with a contract having a pre-defined expiration date.
DXO Market Cap: N/A
DXO Average Daily Volume: 35.8M
PowerShares DB Oil Fund ETF (DBO)
What is DBO? The PowerShares DB Oil Fund (Symbol: DBO) (the “Fund”) is based on the Deutsche Bank Liquid Commodity Index – Optimum Yield Oil Excess Return™ (the “Index”) and is managed by DB Commodity Services LLC (the “Managing Owner). The Index is a rules-based index composed of futures contracts on Light Sweet Crude Oil (WTI) and is intended to reflect the performance of crude oil.
DBO Market Cap: $46.96M
DBO Average Daily Volume: 339,000
United States 12 Month Oil Fund, LP (USL)
What is USL? The United States 12 Month Oil Fund, LP (”USL”) is an exchange traded security that is designed to track the movements of West Texas Intermediate light, sweet crude oil (WTI). USL issues units that may be purchased and sold on the NYSE Arca. The investment objective of USL is to have the changes in percentage terms of the units’ net asset value reflect the changes in percentage terms of the price of light, sweet crude oil delivered to Cushing, Oklahoma, as measured by the changes in the average of the prices of 12 Futures Contracts on crude oil traded on the New York Mercantile Exchange (the “Benchmark Futures Contracts”), consisting of the near month contract to expire and the contracts for the following eleven months, for a total of 12 consecutive months’ contracts, except when the near month contract is within two weeks of expiration, in which case it will be measured by the futures contracts that are the next month contract to expire and the contracts for the following eleven consecutive months, less USL’s expenses. When calculating the daily movement of the average price of the 12 contracts each contract month will be equally weighted.
USL Market Cap: $3.18M
USL Average Daily Volume: 513,000
MacroShares $100 Oil Up Trust (UOY)
What is UOY? MacroShares are issued in pairs: When MacroShares $100 Oil Up are created, an equal number of MacroShares $100 Oil Down are also created.
UOY Market Cap: $7.29M
UOY Average Daily Volume: 15,000
Conclusion
If you compare the chart of WTIC to the charts of 5 oil ETFs or ETNs, none of the oil investment vehicles tracks oil price movement perfectly, the closest match to spot oil price is DXO. It reflects the fact that all the available oil investment vehicles can only mimic oil spot price movement, but none of them can perfectly track spot price.
HardAssetInvestor ran a great article in Feb 2009 to compare the USO and USL, sister funds run by same company, focusing on their pricing structure and impact of contango and backwardation, the conclusion is that USO is more vulnerable to contango situation, while USL may be newer fund to USO therefore not as liquid as USO, but USL addresses contango problem and is liquid enough to serve as a good oil spot price investment vehicle.
Sources:
How do you buy spot oil?
Julian Murdoch
Important Disclaimer: Product price and availability are accurate as of the date of most recent update. Please send correction requests to info@linked8.com
Economy Outlook: Will Monetary Policy Cause Inflation? Timing is Key
Since the outset of economic crisis in 2007, Federal reserve has taken expansionary monetary policy to prevent the economy from falling, the result was a more than 2 folds expansion of Fed’s balance sheet in 2 years from 897B USD by early 2007 to 2013B by early 2009.
With the March 18th FOMC decision, the Fed’s balance sheet is expected to expand further to 3018B by September 2009. The Fed decided on Mar. 18th to expand balance sheet by an additional 1.05T (750B MBS, 100B agency debt, and 300B long term Treasury securities) in next 6 months.
The question is: will this extraordinary measure of increasing monetary base cause inflation? The answer is definitely yes. Even Bernanke himself acknowledged that although the short term assets such as commercial paper, currency swap can be disposed quickly, there are a big portion of long term assets such MBS, T-bonds in Fed’s portfolio that can not be disposed quickly, Fed’s holding of these assets will delay the speed of shrinking monetary base.
The table below shows the assets of Fed’s Balance Sheet (before 1.05T expansion impact),
The table below shows liabilities of Fed’s Balance Sheet before 1.05T additional expansion. The majority of the increase are held as banks’ excess reserves due to bank’s extraordinary concerns to take any risk other than reserving cash with Fed. The bank’s current decision of not distributing these 790B additional cash to the general public is the reason why inflation hasn’t gained its force yet.
However, how much excessive reserve banks decide to put into Fed depends on the general economic condition, when the economy improves, banks will take more risk by lending out more money than now, then the currency available to public will expand, that will cause inflation. So the key to tame inflation is for Fed to shrink the monetary base at a speed that banks decides to lend out more so that currency available to public remains relatively constant.
If this is not achievable, then the how much faster banks will reallocate current reserve cash to the public than Fed shrink’s balance sheet will be how severe the inflation will be.
Source:
More Money: Understanding Recent Changes in Monetary Base
William T. Gavin
The Crisis and Policy Response
Ben Bernanke
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Inflation and Commodity Price: CRB Indices Explained
One way to gauge inflation is to watch commodity prices. CRB index is considered the “S&P 500″ of commodity prices. However, CRB index does not come with one index only, it comes with a series of indices, in at least three groups, what are the differences among them? Let me try to explain here:
CRB Spot Indices
This is the oldest group of indices among the CRB index family, since it started to calculate in 1934 right after Great Depression.
In the 30 years since 1972 to 2006, the index channeled between 200 and 300. The 2008 movement to 400’s level reflects global crisis and recent returning to 300’s level reflects crisis ending is near.
Details about CRB spot indices
Continuous Commodity Indices (CCI)
In contrast to CRB spot indices which shows spot prices of commodities, CCI reflects the commodity futures prices.
The chart of this index shows very flat price before 1972 which reflects great price stability under Bretton Woods system. Right after Nixon abandoned the Bretton Woods system in 1972, the index moved up and never went back to 100 level.
Details about CCI
Reuters/Jefferies – CRB Indices (RJCRB)
Before 2006, the chart shows this index is almost identical to CCI, its composition was changed in 2006 to include crude oil and gold in calculation, while CCI obviously didn’t include crude oil until now.
Details about RJCRB
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Stock Market: Visiting 12 Year Low, Bottom is Near, Analysts Say
It turned out that yesterday something happened in stock market that only happened twice in history: stock index went back to the level of 12 years ago. What does this mean? JP Morgan Chase analysts cautiously took a note of this event as a sign of real bottom being close.
Taking this into account, the bottoming process of this crisis seems to be forming an inverted head and shoulder formation. The Nov. 20th was the left shoulder, right now, the head is being formed. I might be wrong.
On Monday, the Dow closed at 6,763, a level not seen since 1997. If nothing else, the breach of 12-year lows is unusual. Other than Monday’s retesting of 1997 lows, such a crossing has occurred only twice before, on Dec. 6, 1974, and April 8, 1932.
“What we found intriguing is that the 12-year lows were breached at a critical juncture in the bear markets,” JPMorgan Chase & Co. equity analysts Thomas Lee, Bhupinder Singh and Daniel McElligott wrote in a late Monday research note. The breaches were very close to the final lows, they said.
In 1932, the April 8 finish came three months before the market hit its bottom, while 42 years later, the Dec. 6 breach marked the exact end of the 1974 low.
“We do not want to intimate that just because we are visiting levels seen 12 years ago, the bear market needs to suddenly reverse. But since 12-year lows have happened only twice in the history of the index and at important junctures in bear markets, we have to take notice,” the JPMorgan Chase analysts said.
In both 1932 and 1974, recession was still four to nine months away when the 12-year lows were breached. “Nor was the peak in unemployment reached. In fact, in December 1974, unemployment was only 6.6%, on its way to a peak of 9% six months later,” the analysts said.
4/10/2009 Update: The stock market did hit the bottom (the head of the reverse head and shoulder pattern) on March 6th, and it was 666 for S&P 500. Now S&P is in its upswing to form the left side of the right shoulder, I suspect this process will end in May, by that time S&P will tip above 900, then bad news will take the control, and index will draw the right side of the right shoulder, which again takes about 2 months, around July, SPX will hit the right shoulder at around 740 level, and then the real rebound will begin.
Source:
Stocks Bounce off 12-year Lows as Analysts Debate Significance
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