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On
the morning of July 15th, the price of crude oil, the most widely
watched commodity in the world, was gyrating in a narrow range, just above
$145 /barrel, as dealers in London were position-squaring ahead of the Nymex
opening. Just a few days earlier, Iran was conducting war games in the
Persian Gulf and threatening to shut down the Strait of Hormuz, if attacked.
The world watched a fireworks display of Iranian Shahab-3 missiles that were
armed with one ton explosives.
In
the background, the global stock markets were entering into bear market
territory, having lost $13 trillion of value since their peak set last
October. Soaring energy and key raw material costs were squeezing profits of
manufacturers, unable to pass the entire cost increases onto consumers, who
were themselves getting squeezed by soaring prices for gasoline, food and
other basic necessities.
IndyMac
Bank, a prolific mortgage specialist, was seized by federal regulators, in the third-largest bank failure in US
history. Preferred stock sold by Fannie at $25 /share fell to $14 lifting its
yield 13.50-percent. Lehman Brothers’ preferred stock plunged to $9.50
/share to yield 20.8%, discounting its eventual demise. General Motors
suspended its common stock dividend. Hedge-fund trader George Soros
said the global banking turmoil is “the most serious financial crisis
of our lifetime.”
On
July 15th, the Dow Industrials plunged 250-points in the
first-hour of trading to an intra-day low of 10,825, extending its losses to
2,400-points, from eight weeks earlier. Where was the US Treasury’s
“Plunge Protection Team” (PPT) with its magical safety-net,
designed to rescue Wall Street during moments of gut wrenching panic?
“Helicopter” Ben Bernanke was handcuffed by a weak dollar and
gold hovering near $1,000 /oz, and couldn’t slash interest rates to
rescue the market.
US
consumer prices were increasing at a 5% annual clip in June, reflecting the
global commodity boom that the Fed’s rate cuts had set in motion. Then
suddenly, at 10:30 am EST on July 15th, a miracle happened, the Nymex crude oil market began to
collapse, plunging $10 per barrel within a span of less than one-hour, to
its biggest daily decline in 17-years. What was behind the historic crash in
the crude oil market on July 15th that prevented “Black
Tuesday” on Wall Street?
A
few hours later, at 11:30 pm EST, the Bush administration announced a shift
in its foreign policy, and said it would send a high ranking envoy to Geneva,
Switzerland to talk with Iran’s diplomat directly, about Tehran’s
nuclear program. As long as the diplomatic game continues, there is less
chance of any military action against Iran’s nuclear weapons program. At
a cost of one round-trip airline ticket to Geneva, Washington engineered a stunning
15% drop in world oil prices.
On
July 16th, Nevada Senator Harry Reid fashioned a bill to rein-in
speculators in the energy markets, who bet on the price of oil, but
don’t intend to take physical delivery. “This bill will address
the rising cost of gasoline in the short term, and prevent Wall Street
traders from gaming oil markets, and insure that American consumers are
paying a fair price at the pump,” Reid said. The bill would restrict the number of oil futures
contracts an individual speculator could control.
Oil prices have tumbled more than $23 a barrel
from their all-time high set on July 11th, marking the biggest
decline in dollar terms in the market’s history. The evaporation of the
Iranian “war premium” from the oil market, rescued the Dow Jones
Industrials with a “miracle rally” of 800-points, from the brink
of Armageddon. But could there be another hero who is responsible for the
historic slide in crude oil, besides the backroom cabal at the US State and
Treasury departments?
No market travels in a straight line. In the
second half of 2006, the crude oil market fell by 35% to as low as $50
/barrel, before hitting bottom in January 2007. Such is the nature of
commodity markets, which often fool most people, most of the time. The OPEC
cartel was forced to rescue its most precious asset, by slashing oil output
one-million bpd in Nov 2006, to put a floor under the “black
gold” market.
But perhaps, the real hero behind the latest
slide in crude oil is European Central Bank chief Jean “Tricky”
Trichet, who has a penchant for fooling most traders, most of the time.
The world owes a big debt of gratitude to Trichet and the ECB hawks, for
objecting to the reckless strategies of the Federal Reserve, the Bank of
Canada and England, who slashed their interest rates in a state of panic, and
guided the global economy into the “Stagflation” trap.
Instead, Trichet and the ECB hawks refused to be
bullied by politicians into a series of rate cuts, in order to bail-out
over-zealous speculators in the Euro-zone stock markets. Instead, the ECB
held its repo rate steady at 4% throughout the first-year of the global
banking crisis. Then on June 5th, Trichet and the ECB hawks
shocked the global markets, by signaling a baby-step rate hike to 4.25%, and guided
benchmark German schatz yields to their highest levels in six-years.
If the historic rise in crude oil to $150 /barrel
is driven by speculators, as the OPEC cartel and Democrats on Capitol Hill
argue, then the world needs a powerful central bank to go against the
“Big-Easy” at the US Treasury and the Fed, and the “yen
carry” traders at the Bank of Japan, in order to deflate the oil
“bubble” with a classic dose of higher interest rates. “The
simple fact is that there is nearly $250 billion in America’s commodity
futures markets that wasn’t there just a few years ago,” said CFTC commissioner Bart
Chilton on July 22nd.
The ECB’s surprise rate hike to 4.25% is
greasing the skids under the Dow Jones AIG Commodity Index, which has tumbled
-15% below its historic high set on July 2nd, including an -18%
slide in the agricultural sector. Nymex coal has plunged by $40 /ton. Most
importantly, the year-over-year change in the DJ Commodity Index in US$ terms
has dropped in half to 20% in just the past two weeks.
Italy’s
central bank chief Lorenzo Bini Smaghi explained on July 22nd,
“This teaches a lesson to those who wanted the ECB to follow the
expansionary course taken by the Fed. If the ECB had cut rates, today we
would also have a much higher inflation rate. European citizens would have
been the first ones to pay for such a mistake. You need to fight back
immediately against inflation,” he said.
ECB
chief Trichet wasn’t afraid to engineer a decline in the Euro-zone
stock markets, in order to stamp out inflation psychology. “Through the
wealth effect, asset prices have an
influence on demand, and therefore on future consumer prices. So
asset prices are taken into account by central banks,” he explained on
July 17th. Furthermore, Trichet rejects the Fed’s practice
of ignoring food and energy prices. “We
do not consider core inflation as a good predictor of future
inflation,” he said.
So far, the ECB’s rate hike to
4.25% has managed to put a lid on the gold market, and helped to deflate
North Sea Brent by 14% in euro terms. Commodity traders dumped corn and
soybean contracts, which are linked to the energy markets, thru the bio-fuel
connection. The speculative shakeout in agriculture and energy markets eased
inflation pressures, and ignited a rally in the European Banking Index,
rebounding +20% above its panic bottom lows set on July 15th.
German investor
confidence had plummeted to a record low, after Germany’s DAX Index
lost 7% in the first half of July, and 23% this year.
There have been several false bottoms in the DAX that have snared bargain
hunters into bear market traps. But the latest rebound in the Euro-zone stock
markets is based on sounder footing, with renewed hopes for “price
stability” set in motion by the ECB.
However, Trichet was asked on July 18th,
if the worst of the global banking crisis was over, “We are experiencing
a very significant market correction with episodes of turbulence, high
volatility and hectic market behavior. It is an ongoing process. The risks to
growth are on the downside, including the very significant financial market
correction, the possible further increases in oil and commodity prices, and
the possible unwinding of global financial imbalances,” he warned.
The ECB’s surprise rate hike is
widely seen as a one-off event with the Euro-zone economy is showing signs of
fatigue. Industrial output in Germany
and France plunged -2.6% in May, the biggest monthly fall since 1992, and
Italy’s contracted by 1.4 percent. The Spanish economy could
slip into a recession in the second half, after a housing bust pushed-up the jobless rate to 9.9% in May,
the highest in the Euro zone. Still, “price stability” is the
only needle in the ECB’s compass, and if a wage-price spiral takes hold
in Europe, Trichet has vowed to hike rates again.
The ECB cannot handle all the heavy
lifting of interest rates that is necessary to tame the powerful
“Commodity Super Cycle” over the longer-term. There are signs of
a rebellion within the Bernanke Fed, led by Dallas Fed chief Richard Fisher,
and joined by Minneapolis’s Gary Stern, and Philly Fed chief Charles
Plosser, who are calling for a baby-step rate hike to 2.25%, at the next Fed
meeting in August.
“Real interest rates are negative,
and can’t stay there indefinitely. We’ve got price pressures
clearly throughout the economy. Ultimately, rates are going to have to go up,
and the only question is the timing. It’s important that we act before
inflation expectations become unhinged. We need to reverse course. I
anticipate the reversal will need to be started sooner rather than
later,” warned Philly Fed’s Plosser.
“The Fed cannot wait until
financial and housing markets stabilize before raising interest rates,”
said Minneapolis Fed chief Gary Stern on July 18th.
“Headline inflation is clearly too high, and could feed through to core
prices,” he warned. The hawkish remarks by the Fed rebels spooked the
US Treasury market, and yields on the 2-year note jumped a quarter-point to
2.75%, but are still far below the inflation rate.
Combined with Trichet’s hawkish
outbursts last week, the gold market lost its nerve, and surrendered $50 to
$920 /oz. Crude oil slumped to $124. Clearly, a trade-off between a
half-point Fed rate hike and the 15% slide in commodity markets is a deal
worth taking for US central bankers. But the Fed rebels are in the minority
amid a flock of doves at the Bernanke Fed, who dare not lift interest rates,
while the US economy is losing jobs and home prices are falling ahead of an
election.
The rebels at the Bernanke Fed talk
tough about fighting inflation, in order to keep gold bugs off balance, but
eventually, their rhetoric dissipates into thin air. However, the Bank of
Brazil has joined the ECB’s sound-money crusade, and is acting
aggressively to tackle inflation in Latin America’s largest economy,
The BoB hiked its overnight Selic rate 75-basis points to 13% on July 23rd,
and futures markets in Sao Paulo are projecting another half-point increase
to 13.50% by year’s end.
The Bank of Brazil is the world’s
top inflation fighter, and has guided its currency, the real, 16% higher
against the US dollar from a year ago. As a result, the Dow Jones Commodity
Index is only 4% higher than a year ago, in local currency terms.
“Having stable prices is the best path to economic growth,” said
Henrique Meirelles, Brazil’s central banker. “It is important
that the central bank take timely measures so that the country can continue
in its course of growth with low inflation,” he said.
Backed by the central bank’s
massive build-up of foreign exchange reserves, the Brazilian real has become
a top-flight currency to own, and might start to attract the interest of
sovereign wealth funds. However, the ballistic Brazilian Bovespa Index is
sliding into bear market territory, weakened by the downturn in global
commodity markets and the central bank’s tighter monetary policy.
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www.sirchartsalot.com
Mr
Dorsch worked on the trading floor of the Chicago Mercantile Exchange for nine years as the chief
Financial Futures Analyst for three clearing firms, Oppenheimer Rouse Futures
Inc, GH Miller and Company, and a commodity fund at the LNS Financial Group.
As
a transactional broker for Charles
Schwab's Global Investment Services department, Mr Dorsch handled
thousands of customer trades in 45 stock exchanges around the world,
including Australia, Canada, Japan, Hong Kong, the Euro zone, London,
Toronto, South Africa, Mexico, and New Zealand, and Canadian oil trusts,
ADR's and Exchange Traded Funds.
He
wrote a weekly newsletter from 2000 thru September 2005 called, "Foreign Currency Trends"
for Charles Schwab's Global Investment department, featuring inter-market
technical analysis, to understand the dynamic inter-relationships between the
foreign exchange, global bond and stock markets, and key industrial
commodities.
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