Tag: finance

While one can blame algos and “macros” for snapping up oil the commodity, as Morgan Stanley did recently, another question is who is the relentless buyer of energy stocks to a level that makes little sense from a forward P/E multiple.

The answer may have been revealed earlier today in Bank of America’s breakdown of what smart money investors were doing. While we already reported that for the 13th, record, consecutive week, hedge funds, institutions and private clients were unloading risk exposure, one other group of client were buying energy stocks in record amounts: Pensions.

This is what BofA said:

Pension fund clients—a sub-set of institutional—were net buyers of US stocks for the second week, led by record purchases of Energy stocks by this group. They were also big buyers of Industrials and Tech. Unlike the other groups, pension fund clients are net buyers YTD.

In other words, as virtually all other institutions are exiting the market at a record pace that has surprised even Bank of America, one specific subset of “clients” is buying energy stocks with reckless abandon at multiples that only make sense if oil was back at $80: the same group who is tasked with the fiduciary duty of protecting your pensions, dear retired readers.

Which provides a convenient scapegoat for why pensions are set to be wiped out even faster than has been the recent case: blame it all on oil.

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Yesterday’s 2 Year auction was surprisingly poor because, among other things, it was the first tailing auction since 2014. Moments ago the US Treasury sold $34 billion in another lackluster auction which saw the high yield print at 1.41%, tailing 0.2 bps through the When Issued.

The Bid to Cover was 2.41, modestly better than last month’s 2.38, if in line with the 6 month average.

The internals were modestly better, with Indirects taking down 63.4%, 10 bps higher than a month ago, while Directs took down 6.8%, leaving 29.8% for the Dealers, a rather conventional distribution.

To be sure, the weakness was not unexpected: not only was the OTR not trading special in repo this morning suggesting little short overhang, but with the Fed announcement in just two days, we doubt many were eager to put down capital in an auction that may see substantial whipsawing in just over 48 hours.

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Submitted by Charles Kennedy via OilPrice.com,

Venezuela – home to the largest oil reserves in the world – will for the next 40 days experience a four-hour blackout every single day, and there are fears that the rationing could lead to unrest and trigger a decline in oil output at a time when the country is barely hanging on.

The decision to ration electricity was brought about by a severe drought that has rendered the level of the Guri dam – the country’s major source of power generation – so low that if the weather doesn’t change, the authorities will have to shut it down.

The blackouts will affect households and industrial users alike–and it’s very likely that oil production will drop. This drop, however, will not be too significant, especially in the current state of oversupply.

The Financial Times last week quoted analysts as estimating that irregular power outages could lead to a daily decline in oil output of between 100,000 and 200,000 barrels. That’s a little less than 10 percent of the average daily output in the country for last year, according to OPEC data.

Besides the power outages and the 40-day power rationing, the Venezuelan oil industry has been hit extremely hard by the recession that Venezuela has plunged into because of the oil prices crash. No cash for investments and infrastructure deterioration are the main problems of the industry and they are unlikely to get a solution anytime soon.

Venezuela’s economy is entirely dependent on oil revenues, which is why the country was so insistent on agreeing to a production freeze with other OPEC members. Unfortunately for the South American nation, no freeze was agreed upon, so it has been left to take care of its problems on its own.

To top it all off, crude oil benchmarks started the week with losses, after a three-week rally that was largely the result of bullish hedge fund activity, speculation, and forex movements, according to Morgan Stanley. These factors can’t help Venezuela. What it needs is a fast and sustainable improvement in oil’s fundamentals that would prop up prices. Such a development, however, is nowhere on the horizon.

The International Monetary Fund (IMF) has warned that this year, inflation could jump to a staggering 481 percent, up from 122 percent last year. The economy is expected to contract by 8 percent. Whatever action the government takes, it seems ineffective. Limiting access to foreign currency, food and essential item shortages, as well as price controls have been all deemed as failures by observers.

The effectiveness of power rationing is also questionable. One Venezuelan sector analyst told Bloomberg that rationing will make matters even worse, deepening the chaos; though many parts of the country aren’t likely to notice because they’ve been suffering from day-long power outages already.

So, this is where the world’s top oil reserve holder is: three-figure inflation, the worst recession in the world and no light in sight for oil, the commodity that Venezuela depends on for its survival.

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During the last week we have highlighted the frightening similarity between the speculative spike in China commodity trading (which has sent industrial metals prices soaring in yet another 'error' signal for real supply and demand) and the pump-n-dump in Chinese stocks. Specifically, as Goldman warns the factor that "concerns us the most is the increased speculation in the Chinese iron ore futures market," and now, as Bloomberg reports, it appears that bubble is bursting as Steel and Iron Ore prices tumble most in 21 months after Chinese exchanges raise margins in an attempt to curb speculation.

This is what the commodity insanity looked like!!

Bloomberg notes that:

Goldman Sachs has expressed its concern about the surge in speculative trading in iron ore futures in China, saying that daily volumes are now so large that they sometimes exceed annual imports.

 

The increase in futures trading in the world’s largest importer was among factors that have lifted prices, according to a report from analysts Matthew Ross and Jie Ma received on Tuesday. Iron ore volumes traded on the Dalian Commodity Exchange are up more than 400 percent from a year ago, they said.

 

“While increased fixed-asset investment in China, a bring-forward of steel production (ahead of a government curtailment) and mining disruptions help to explain the strong rally in the iron ore price, the one driver that concerns us the most is the increased speculation in the Chinese iron ore futures market,” they wrote.

 

As we said ast week, eventually, the excesses will need to be curbed and maybe that starts a new phase of risk-off within China: As one local trader put it:

 

 

“The market is moving so quickly, yesterday felt just like the stock market in June last year before the crash… I think how it goes up, that’s how it will come down."

“There have been two days in the past month where futures volumes have been greater than the total amount of iron ore that China actually imported for the whole of 2015 (950 million tons),” the Goldman analysts wrote.

And so, as Bloomberg adds,

To slow trading activity, the Dalian exchange has announced it would be increasing margin requirements and transaction costs on iron ore futures, they said.

nd that has sent commodity prices tumbling…

The most-active Iron ore futures contract dropped as much as 4.4 percent on Tuesday after the exchange doubled trading fees.

 

The benchmark spot price for ore with 62 percent content delivered to Qingdao fell 5 percent to $62.78 a dry ton on Tuesday, up 44 percent this year, according to Metal Bulletin Ltd.

 

 

Other raw materials in China were also in retreat on Tuesday. Coking coal futures, which trade in Dalian, reversed early gains to lose as much as 5 percent to 777.5 yuan ($120) a ton.

As Goldman concluded:"the commodity rally is not sustainable" and along with it the Baltic Dry's misplaced confidence signals.

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It had already been a very bad several years for hedge funds with 2016 starting off especially brutally, as Goldman’s own Hedge Fund VIP basket demonstrates…

… when moments ago we learned that it is about to get even worse for one of the most iconic names in the macro hedge fund space, Brevan Howard, which according to Bloomberg has been served with $1.4 billion in cash redemption requests.

Brevan Howard co-founder Alan Howard

As Bloomberg writes, investors in Brevan Howard Asset Management have asked to pull about $1.4 billion from the firm’s main hedge fund after successive annual declines followed by losses during the first quarter, according to two people with knowledge of the matter.

The Brevan Howard Master Fund, which bets on macroeconomic trends to invest across asset classes, will have to meet the redemption requests by the end of June, said the people who asked not to be identified because the information is private. The fund managed $17.6 billion at the end of March, down from about $27 billion two years ago, according to a company website.

While the firm’s billionaire co-founder Alan Howard has previously said that there will be “exceptional opportunities” to make money this year, those have so far failed to materialize. What is odd is that Brevan’s losses are once again not even that material: the Master Fund closed the first quarter down 0.97 percent after losing 2 percent in March. It dropped almost 2 percent in 2015 and 0.8 percent in 2014, people familiar with the matter said earlier this month.

This, however, appears sufficient for many LPs to send in their redemption papers.

Investors disappointed by hedge funds’ performance during recent market turmoil pulled the most money last quarter since the tail-end of the financial crisis, according to Hedge Fund Research Inc. Money managers betting on macro economic trends suffered $7.3 billion in outflows.

The recent trend of pulling funds away from hedge funds is not new: recently New York City’s pension for civil employees, whose money managers included Brevan Howard, voted this month to pull $1.5 billion from hedge funds. Clients of Tudor Investment Corp. have asked to withdraw more than $1 billion from the firm founded by billionaire Paul Tudor Jones after three years of lackluster returns, while Och-Ziff Capital Management Group LLC saw its assets fall by about $1 billion in March to $42 billion on April 1, according to a company filing.

As central banks continue to take over capital markets and make fundamental-based investing impossible, we expect even more hedge fund casualties who collect 2 and 20 in a worldin which activist central bankers have become the Chief Risk Officers of broader markets, and better yet, they do it for “free.”

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Submitted by Ian Armstrong via GlobalRiskInsights.com,

The recent failure of North Korea’s missile tests reaffirms the deficiencies of its ballistic and nuclear programs. Perversely, it also increases the risk of an imminent greater destabilizing behavior.

On April 15th, Pyongyang attempted and failed a test launch of a land-based ballistic missile that, if properly deployed, is capable of hitting a target 2,400 to 3,200 miles away.

One week later, leader Kim Jong Un conducted a second missile test via submarine. While the follow-up was more successful than the first (which exploded within seconds of lift-off), it only traveled for a mere 30 km — shy of the standard 300 km needed for a ballistic missile launch to be considered successful.

Outwardly, these two failures appear to demonstrate that Pyongyang’s ballistic missile and nuclear programs are still relatively unsophisticated and incomplete. These conclusions, however, are superficial. In reality, both launches have revealed the increasing capability and ambition of North Korea’s atomic efforts.

They have also — through their publicly lackluster outcomes — elevated the short-term risk of further sporadic, destabilizing military actions from the Kim regime, with damaging implications for international security and finance.

Hastened progress on DPRK nuclear program

The April 15th and April 23rd missile tests are a clear continuation of the increasingly frequent antagonistic efforts undertaken by North Korea, otherwise known as the Democratic People’s Republic of Korea (DPRK). As a result of various nuclear and missile technology tests conducted by the rogue regime earlier in 2016, Pyongyang’s nuclear capacity has been increasing at an accelerated rate.

Although both tests were, at least from a definitional standpoint, unsuccessful, they serve to compound this accelerated trend of technological progression — and therefore geopolitical instability.

First and foremost, North Korea gains a significant amount of technological know-how from missile tests regardless of the degree to which they succeed. The lessons learned from the April tests, in spite of their failures, will be applied to future missile iterations and ultimately hasten the pace at which the DPRK develops vehicles for delivering nuclear payloads. In short, the rate at which tests occur is a strong indicator for the speed of program development.

Furthermore, while both tests failed by large margins in achieving the full-flight of a non-tactical ballistic missile, to label the second attempt as a complete “failure” is a misnomer. For one, the launch represented clear improvement from North Korea’s previous submarine-launched missile test in December, which failed at ignition.

It also utilized a more energetic and sophisticated fuel source that was not previously recognized as a functioning component North Korea’s missile repertoire. In achieving at least 30 km of missile flight, the DPRK has thus demonstrated a faster than expected growth in WMD-related abilities.

Greater likelihood of provocations

On its own, North Korea’s growing missile capacity has thus far done little to stoke the kind of geopolitical tension that steadily contributes to volatility in financial markets. The one exception appears to be the short-term volatility that follows full-scale North Korean nuclear tests.

Prior to the April missile tests, South Korean intelligence agencies had already concluded that a fifth DPRK nuclear test would occur in 2016, specifically pointing to satellite imagery showing the resumption plutonium production and increased activity at known nuclear test zones.

Unfortunately, the fact that these two particular launches performed below the standards of successful ballistic missile tests increases the chance that another North Korean nuclear test is imminent within next 1-3 months. In May, Kim Jong Un will oversee the 7th Congress of the Workers’ Party of Korea, an extremely rare meeting of North Korea’s highest political body that last occurred in 1980.

Timeline of Previous North Korean Nuclear Tests

At the Congress, it will be in the interest of the Kim regime to underscore his contributions to the progress of North Korea’s military, the core of which is its rogue nuclear program. As such, it is likely that Kim will utilize a powerful nuclear test to erase any notion of failure brought about by the lackluster tests in April.

North Korea’s nuclear tests may not have demonstrated the full-flight capacity that world powers have sought to prevent for decades, but they do impose a greater short-term risk of a nuclear test to compensate. Such a risk entails both heightened geopolitical tensions and brief financial volatility, particularly in the Japanese and South Korean markets, where the threat from North Korea is most acute.

Perhaps acknowledging the greater likelihood of a nuclear trial, North Korea offered world powers a diplomatic solution on Sunday: Cease U.S.-South Korea military exercises, and DPRK nuclear tests will halt. Knowing the hollowness of Pyongyang’s word, both countries declined. If diplomatic history is any indicator, there is little that world powers can or will do to prevent North Korea’s looming nuclear test.

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“Forgive the macros – they know not what they do.”

That is how Morgan Stanley’s Adam Longson begins his note explaining why while risks for oil continue to rise, the “macro rally can persist.” Specifically he says that while “oil continues to rise on the back of macro funds, CTAs, index/ETF flows and investors fearful of missing out” the fundamentals remain bearish and are set to deteriorate further, “esp if prices move higher. Non-fundamental rallies can last for several months and near-term catalysts may be lacking, but a macro unwind could cause severe selling given positioning and the nature of the players in this rally.”

In justifying the relentless “macro” driven buying, Longson writes that “close your eyes and buy seems to be the mantra for now.”

Here a curious question emerges: will the algo buying push oil back to the $60/bbl level we saw last summer. This is his answer.

While fundamentals don’t justify a cyclical recovery in oil yet, the market continues to move higher. The primary driving force has been macro funds, index money and CTAs. Technicals and momentum have only added to it, and there is a sense from some of investors that they need to buy for fear of missing out. Also similar to 2015, we see a confirmation bias where any bullish data point is embraced (e.g. supply outages, weekly US production, etc) and bearish data points are dismissed or spun as a buying opportunity (i.e. the worse is behind us).

 

Non-fundamental rallies can last for several months before the physical market pushes back. In 2015, the rally to $60 WTI lasted for over 2 months.

 

 

Yet, unlike other assets, there is a physical market behind commodities. If prices move too early, there are real world implications, even if those facts are slow to play out. It’s one reason why expectations investing is less effective in commodities. Nothing happens until it happens. Fundamentals are poor and set to deteriorate. The macro/CTA players are mostly generalists and quants expressing a macro view. Yet, the market impact underscores how macro and technical oil trading is at the moment. The problem is that prices are approaching important fundamental levels, and the fundamental trends look worse.

Meanwhile, the fundamentals are set to deteriorate:

Fundamentals are poor and set to deteriorate. The macro/CTA players are mostly generalists and quants expressing a macro view. Yet, the market impact underscores how macro and technical oil trading is at the moment. The problem is that prices are approaching important fundamental levels, and the fundamental trends look worse.

 

A significant number of supply outages are set to resolve in the coming weeks/months.

• OPEC production could rise nearly 1 mmb/d from Mar – June, and Doha’s failure could setup a market share war with many producers now calling for growth.
• Prices above $45 WTI will start to impact the rate of decline in US supply and should attract much more producer hedging. We are also already seeing increased appetite for energy lending after this move – a reversal from Jan, which excited the market.
• Gasoline trends in Asia look quite poor with tankers of product floating off Asia. EM ex. China oil demand has also been underwhelming, which is the key area of growth.

Near-term catalysts may be lacking, but a macro unwind could cause severe selling pressure. The extreme long spec positions from many of these funds could prove problematic. Realization of the MS economics and FX views could setup for an unwind in 2H16 given their sensitivity to macro trends.

Note that as we pointed out over the weekend, net spec positions recently shifted from record short to record long. This may be just the positional unwind catalyst that leads to Longson’s “severe selling pressure.” That and the realization that Mid-east is now skewed bearish.

The Middle East is skewed bearish, in contrast to the optimism surrounding energy in the US and Europe. We spent several days in the Middle East last week with corporate clients and investors. While US investors are increasingly bullish based on US trends, the tone in the Middle East was much more bearish, particularly near term. Several investors stated they would be sellers if oil reached $50. While every region can be biased by local life, we find this sentiment interesting given the importance of the debate around OPEC supply and Middle East demand.

 

Several key ideas and concerns were reiterated:

 

1. A view that OPEC production is likely going higher, not lower. The view was that hoping for OPEC intervention is and has been misguided. Perhaps this investor base is too close to tensions in the region, but most investors expect OPEC and potentially Russian production to rise post-Doha. Conversely, macro funds and CTAs are driving the front higher, and now there are renewed hopes on the tape of another production freeze meeting or positive trends at the OPEC meeting.

 

In our base case, we see OPEC production rising nearly 1 mmb/d by June from Mar-16’s 32.5 mmb/d. Much of the increase is simply a seasonal ramp from Saudi Arabia, Iran’s ramp, and outages resolving. With more aggressive efforts from Saudi Arabia, Iran and Kuwait, production could rise above 34 in short order, which would offset both our estimated global crude demand growth and US declines for 2016. 35.5 mmb/d is possible with Libya, more Iran success and Saudi Arabia at 11.5.

 

2. Opinions on EM demand and GDP were not optimistic. We heard concern about the impact of reform and oil subsidy removal on local GDP and oil demand, inline with our view. We find this particularly interesting from an investor base able to view these changes in real time. We also heard concerns about the sustainability of the EM rally and China stimulus.

 

3. There is a concern that US supply might respond if oil moves higher too quickly. Most investors expressed that oversupply still exists and that shale has permanently changed the dynamic of the oil market.

 

Finally, MS touches on a topic we discussed a month ago when we explained that the collapsing prompt contango is about to shift into backwardation making offshore storage unprofitable. Here is MS:

Brent backwardation reflects regional supply issues, not an improving balance. As of mid-April, the Brent 1-2 time spread became backwardated (a situation where the front month oil futures contract trades at a premium to the second month futures contract). As we’ve long noted, there is a strong link between regional storage and prompt month structure, and such a situation typically indicates physical supply tightness for the contract time frames. The same is true here, as front-month Brent is trading June 2016 delivery, which coincides with higher North Sea field maintenance and seasonally strong refinery demand.

 

We continue to stress this is a temporary regional dynamic, that has occurred many times in the past, not a bullish global signal. Given the very limited streams and production supporting the BFOE market, lost cargoes and incremental buyers can move the market significantly. This was particularly pronounced during 2012/13 when a Korea tax arbitrage drove incremental buying of Forties and periods of sudden steep backwardation. Upcoming North Sea field maintenance also has a history of lifting prompt month Brent spreads, which then typically fade as supply returns. Global outages in the Atlantic Basin have only reinforced the near term impact. However, we’ve already seen the magnitude of backwardation begin to fade heading towards expiry even as flat price rises.

 

Backwardation likely attracted additional inflows from passive investors. Passive commodity investment tends to follow commodities that are in backwardation as they not only provide a venue for profiting from overall price appreciation but also provide positive roll yield. As Brent flipped into backwardation, it likely attracted more inflows from index strategies.

 

Brent’s upcoming roll could be a negative catalyst: backwardation is not present beyond the prompt month. As a result, we would expect that when the backwardation dissipates (i.e., when the June Brent contract expires at month-end and the market is no longer pricing forward outages/maintenance), this  incremental passive investing could slow or exit the market, adding downside pressure to front-month pricing.

 

So does all that matter? Judging by today’s spike in oil, which just pushed above $44, and is now above key resistance levels, the CTA and other “macros” remain firmly in control as fundamentals continue to be completely ignored. For how much longer this can continue is anyone’s guess.

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Everything is going wrong for the GOP establishment. Yesterday, 'the alliance' broke down within hours of being conjured into life, and today the anti-Trump-ers face disaster as a new NBC poll shows Donald Trump has reached 50 percent support from Republicans and Republican-leaners nationally for the first time since the campaign began.

This milestone is significant as the 2016 primary heads into its final few weeks of contests, as there has been intense speculation that Trump's support has a ceiling. Though his support has hovered in the high 40s since mid-March, the front-runner had yet to secure half of Republican voters.

Overall, this week's 6-point swing – Trump up 4 points, Cruz and Kasich down 2 points – is the biggest weekly shift in the poll so far. Combined with his significant win in New York, Trump's rise nationally could be an early sign of consolidation within the Republican Party.

As Goldman notes, after a brief period of uncertainty following the Wisconsin primary earlier this month, the Republican nomination once again looks like it is Mr. Trump’s to lose, while Sec. Clinton appears to have a tight grip on her party’s nomination and could clinch it outright (including “superdelegates” in the total) before the last of the contests in June.

The outcome of the Republican nomination looks unlikely to become clear until the convention.

If Trump fails to win 1237 delegates in the contests through June 7, his remaining option to secure the nomination would be to win the support of unbound delegates before or even during the convention, which starts July 18. Under the hypothetical delegate scenario illustrated above where Trump wins around 1200 of the delegates but falls short of a majority, he would need to work to gain the support of another 37 or more unbound delegates, out of around 150 total. However, a number of these delegates have already announced their support for other candidates (e.g., Sen. Cruz), leaving a smaller pool for Trump to draw from. The April 26 primary results in Pennsylvania could shed some light on this question; Pennsylvania will send 54 unbound delegates to the convention—the largest amount from any single state—and some Pennsylvania delegates have suggested they might feel obliged to support their state’s winner (though others have already announced support for a candidate regardless of the results). We would expect to see additional scrutiny of these delegates’ intentions in coming days.
 

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If there was some confusion why the Atlanta Fed recently revised its GDP Nowcast higher following the recent retail sales miss, that confusion will be even more acute today when moments ago the Atlanta Fed plugged today’s weaker than expected durable goods print (and downward revision to past month’s data), and ended up with… a GDP forecast that was higher than previously, or an increase from 0.3% to 0.4%.

From the Atlanta Fed’s Nowcast:

The GDPNow model forecast for real GDP growth (seasonally adjusted annual rate) in the first quarter of 2016 is 0.4 percent on April 26, up from 0.3 percent on April 19. After last Wednesday’s existing-home sales release from the National Association of Realtors, the forecast for first-quarter real residential investment growth increased from 8.5 percent to 10.8 percent. After this morning’s advance report on durable manufacturing from the U.S. Census Bureau, the forecast for real equipment investment growth declined slightly while the forecast for real inventory investment increased slightly.

 

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