Market Observations with Chris Puplava

Chris Puplava

Betting On Oil

Opportunity of the Decade?

By Chris Puplava, January 10, 2007

In the context of the New Year I thought I would try something new--writing my own macro theme picture for 2007. There are several topics I want to cover and will put them out over the next several weeks. With the recent beating in energy stocks precipitated on the unseasonably warm weather this month, I thought I would start there and look at some long term trends and the fundamentals.

Previous Manias

There is a season for everything and each decade has had its own mania as the chart below illustrates.

Figure 1

Source: BCA Research

In the 70s we saw gold go through the roof as well as energy stocks as inflation soared. Higher oil prices translated into higher sales and the oil sector was the best performing sector of the 70s, and gold was the best performing asset class.

Figure 2

Source: http://www.gummy-stuff.org/sector-returns.htm

In the 80s we saw the Tokyo Nikkei Average index soar from ~ 7,500 to 37,500 (+400%) and was the mania bubble of the decade.

Figure 3

Source: StockCharts.com

In the 90s it was NASDAQ which became the decade's bubble with chip stocks putting in the best sector performance.

Figure 4

Source: StockCharts.com

Figure 5

Source: http://www.gummy-stuff.org/sector-returns.htm

So what will to be the mania for this decade? There are many candidates, but those that appear the most likely are similar to those seen in the 70s, precious metals and energy. The AMEX Oil Index (XOI) is up from the low of 416.71 in early 2003 to the a reading of 1131.78 as of January 3rd (+172%), and gold is up from a low of $257.90/oz in early 2001 to $629.80/oz (+144%) as of January 3rd. An even greater run has been seen in uranium, which has surged unabated in its performance since the start of its bull run in 2003 at roughly $10/lb to the current $72/lb, up 620%.

Figure 6

Source: StockCharts.com

Figure 7

Source: Sharelynx.com

When looking at the price performance of the S&P 500 sectors, energy is clearly in the lead as are the sales of the energy sector when the sales of the ten sectors are normalized to 100 as seen by the graph below.

Figure 8

Source: Aggregate sales of top ten market cap stocks in each sector normalized to 2000 sales
as cited in annual reports.

How does the current bull market in energy stack up to previous manias in decades past? The following figure is the Oil Service Index (OSX) overlaid with the Nikkei Index. The starting date for the OSX index used was September 26th, 2001 with data through January 3rd's close.

Figure 9

Source: Moody's.com & Bloomberg

The path followed by the oil service industry mirrors that of the Nikkei index fairly closely, except for periods of volatility seen with the hurricanes of 2005 (corresponding to year 1988 on chart above). With the slowdown in the U.S. economy likely to reverse course later this year or early 2008, its not hard to envision energy stocks rising through the end of the decade as U.S. energy demand reaccelerates to add to the ever rising demand from emerging economies like China and India.

Supply & Demand Fundamentals

Despite weakness in the U.S. economy, the fundamentals for energy still remain strong. Global oil demand is rising in the face of falling oil production and OPEC cuts. Since the sharp rise in global oil demand in 2004, oil demand has been decelerating and even briefly turned negative in early 2006. However, global oil demand has since reaccelerated and has remained on an upward path since the same time production has been falling.

Figure 10

Source: BCA Research

A significant portion of the incremental demand over the past few years has come from developing parts of the world, specifically China and India. Below is a figure from a Federal Trade Commission's study on gasoline price changes which shows predicted oil demand increase and actual demand increase. Projections were for a 1.5% increase in Chinese demand for 2004, but the actual increase was more than double the projections at 3.3%.

Figure 11. 2004 Predicted vs. Actual Crude Oil Demand Increase
(Million Barrels/Day)


Source: FTC

The sharp increase in Chinese demand has come from the booming export industry as the country industrializes, leading to a shift in demographics as the rural population decreases and shifts to urban areas. The swelling in the number of Chinese workers has brought down unit labor costs and has allowed China to produce cheaper goods (with an undervalued currency also contributing) making it more competitive in the global export economy.

Figure 12

Source: BCA Global Investment Strategy - December 15, 2006

This shift in the population demographic of China over the past two decades is projected to continue, according to the United Nations, and is not isolated to China. The chart below shows that the percentage of the Chinese population in rural areas is expected to decline from 80.4% in 1980 to 39.5% by 2030 and conversely, the percentage living in urban areas to triple from 19.6% in 1980 to 60.5% by 2030.

Figure 13

Source: United Nations

Also seen in Figure 13 is a smaller decline in India, with the rural population shrinking from 76.9% of the total population in 1980 to a projected 58.6% by 2030, with the Korean population seeing a reduction from 43.1% to 13.8% over the same time span.

Even though the Chinese population in urban areas has doubled from 19.6% in 1980 to 40.5% in 2005, the oil consumption of China as measured by barrels per person per year remains significantly low relative to the industrialized nations of the U.S., Japan, and South Korea.

Figure 14

Source: BCA Research

The gap between the oil consumption of China and the industrialized nations of the U.S. and Japan shows the potential strain on the global energy economy that will be faced in the future as China continues its industrialization, shifting from a population of bicycles to cars. This shift from bicycles to cars is already accelerating as General Motors (GM) and Ford saw sales in China jump sharply last year (click here for article link).

GM said that Chinese vehicle sales rose 32% in 2006 over 2005 to 876,747 vehicles. Kevin Wale, president of GM China, said that, "Vehicle sales continued to outpace most projections as a result of unprecedented consumer demand for passenger cars." Ford saw an even greater increase in sales with 2006 sales rising 87% over 2005 to 166,722 units. Competition among automakers has intensified to grab a share of the Chinese market which is expanding at double-digit annual rates. The article mentioned that total vehicle sales in China are expected to rise by 15% to 8 million this year from the estimated 7 million in 2006, according to the China Association of Automobile Manufacturers.

As the number of vehicles in China rises, so will the Chinese consumption (gray) curve in Figure 14, with Chinese oil consumption per capita increasing and adding to the strain on global oil demand. The affect that the emergence of China's industrialization has had on global oil demand and supply can be seen by the jump in crude prices in 2004, with actual Chinese demand coming in at more than 500,000 barrels per day above the estimated 300,000 barrels per day projected (Figure 11). The price of West Texas Intermediate Crude (WTIC) rose from $35 a barrel in January 2004 to $55 in October of 2004, up 57% as incremental Chinese and Indian oil demand reduced OPEC spare production capacity (narrowing of gap in Figure 16).

Figure 15. 2004 Price Chart of WTIC

Source: StockCharts.com

Figure 16. OPEC Excess Capacity vs. OPEC Production

Source: Matthew R. Simmons, "Tight Oil Supplies,"
Simmons & Co. International, May 2006, p. 6

For the most part, U.S. demand for oil has been the principal determinant of oil prices as the U.S. is the largest consuming nation. This correlation can be seen in U.S. inventories and the price of oil (WTIC) where a contraction in crude inventories lead to a rise in oil prices and vice-versa.

Figure 17


Source: Moody's Economy.com
Data: Federal Reserve Bank of St. Louis, Energy Information Association

What the two figures above show is that the correlation of U.S. inventories and world oil prices ended in 2003 as U.S. crude oil inventories have been on a rising trend as have oil prices, representing a positive correlation in contrast to the negative correlation seen prior to 2003. No longer is the U.S. (as determined by U.S. inventories) the predominant factor in determining world oil prices, as crude oil is rising in the face of rising U.S. inventories. This can be explained by the entrance of emerging nations like China and India (Chindia), which have contributed to a reduction in global spare oil capacity despite rising global oil production.

Evidence of the importance of emerging nations relative to developed nations on global oil demand can be seen in recent supply and demand trends. Demand for oil has been slowing on a year-over-year (YOY) rate of change since peaking in 2004, but so has the YOY supply growth rate which is currently negative (Figure 18 below). Oil consumption for OECD (Organization for Economic Cooperation and Development) countries is currently growing at a negative YOY growth rate though global demand is still growing. Global growth in oil demand in spite of declining OECD demand is coming, to large degree, from Asia where Chinese demand came in larger than the expected level in the second quarter of 2006. This is significant in the fact that declining oil demand in developed nations is being more than offset by emerging nations as the global demand growth rate remains positive.

Figure 18

Source: DismalScientist

To visualize the shift of importance in determining oil prices from the U.S. economy to emerging and developing Asian economies look at the table below (Table 1), which shows the demand for oil in 1995 and 2005. Oil demand in North America grew by 17.6% while the fastest growth in demand came from the Middle East and Asia Pacific, which grew by 35.4% and 32.5% respectively.

Table 1

Source: BP Statistical Review of World Energy, June 2006

On an absolute basis of comparing demand increases for crude, the fastest growing demand over the period for crude oil came not from North America, but from emerging and developing nations. A more significant analysis comes from an apples-to-apples comparison of relative growth rates in terms of the total global demand increase for the period. This is accomplished by taking the increase in demand for a region divided by the total global increase to determine a country's share of the global growth in crude oil demand. As Figure 18 below shows, China is the greatest country responsible for the increase in crude oil demand from 1995 to 2005. China saw the second fastest growth in crude oil demand of 32.5% (absolute basis) and the largest share of the global demand increase (relative basis), representing the lion's share with 45.4% of incremental global demand. China made up nearly half of the total global incremental demand from 1995 to 2005 underscoring its importance on future oil demand.

Figure 19

Source: BP Statistical Review of World Energy, June 2006

World production capacity in 1985 was 70 million barrels a day, with spare capacity at 10 million barrels per day, and the refinery utilization rate at 78%. In 2005, world oil production capacity rose to 85-86 million barrels per day, with spare capacity falling to 1-2 million barrels per day and the refinery utilization rate rising to 92+% (Source: BP Statistical Review of World Energy, June 2006).

The emergence of Chindia has increased the strain on the global crude oil market by leading to a reduction in spare oil capacity from 10 million barrels to 1-2 million barrels a day at the same time spare refining capacity has fallen from 22% to roughly 8%. The issue of the strain on spare oil capacity and refinery utilization is only part of the problem.

Falling Productivity & Production

A significant factor contributing to the dwindling growth in crude oil supply, which is currently negative, comes from falling productivity rates. Oil and gas wells are both producing at lower levels than they once did as they become more mature, with productivity declining steadily since the early 1980s.

Figure 20

Source: BCA Research

On top of falling productivity is a decrease in new discoveries, with the last year that we discovered more oil than we consumed occurring over 25 years ago. The figure below shows past discoveries along with production. The biggest oil fields were discovered 50 years ago (point 1) with peak oil discovery coming in 1965 (point 2) and the last major oil discoveries being made in the 1970s. Since 1965 global oil discoveries have been on a steady decline with production on a steady incline eating away at global inventories as production outstrips new discoveries.

Figure 21
|
Source: The Empty Tank, Jeremy Leggett, 2005, p. 32

One of the results of falling well productivity has been a need for more drilling rigs to bring on more supply to make up for the loss in productivity per well. The number of drilling rigs has surged since the start of this decade as the U.S. economy came out of a recession, and emerging nations economic growth accelerated (like China's), increasing demand for crude oil and natural gas.

Figure 22

Source: Moody's Economy.com Data: Department of Energy (DOE)

Figure 22 shows both oil and gas drilling rigs in the U.S. with a greater surge in natural gas drilling rigs than oil. The number of drilling rigs for both energy products correlates with the number of exploratory wells drilled shown below.

Figure 23

Source: Moody's Economy.com Data: Department of Energy (DOE)

There are two principal reasons why the number of natural gas drilling rigs has risen faster than oil. For one, U.S. natural gas production has fallen since peaking in 2001. To make up for the falling production, more wells have been needed to be drilled requiring more natural gas drilling rigs.

Figure 24

Source: Moody's Economy.com Data: Department of Energy (DOE)

Figure 25

Data Source: U.S. Natural Gas Production (Y-Y Change) by Raymond James, August 2006

Another reason why the number of natural gas drilling rigs has risen faster than oil rigs is that natural gas is not as easily transported as oil by its very nature of being a gas. Natural gas fields need to either be connected to a pipeline or liquefied for transportation while crude oil is not under the same constraints. Thus, even though U.S. crude oil production is falling like U.S. natural gas production, we can import our oil to make up for the shortfall in domestic production, unlike natural gas where we do not have an extensive infrastructure to handle liquefied natural gas imports. U.S. imports of oil have risen steadily since 1985 and the year 1998 marked an important date for the U.S. as that was the year we imported more oil than we produced.

Figure 26

Source: Moody's Economy.com
Data: Department of Energy (DOE), American Petroleum Institute (API)

The decline in U.S. natural gas and oil production and productivity and the subsequent surge in demand for drilling rigs, has lead to phenomenal operating performances for drilling rig companies. Grey Wolf Inc.'s (GW) management had the following to say in their third quarter 2006 Management Discussion and Analysis:

We believe the long-term fundamentals for our business are good. Natural gas production decline rates are steeper than ever, and despite record drilling levels during the past several years there has been no meaningful increase in domestic natural gas production.

This has indeed been the case despite a common analysis that, as the number of drilling rigs rose, production levels would rise as well leading to the supply of drilling rigs outstripping demand and profits for drilling companies peaking. This would be a logical conclusion as the current total number of drilling rigs of over 1,600 is the highest number in operation in over 20+ years.

Figure 27

Source: Moody's Economy.com Data: Baker Hughes Incorporated

A collapse in drilling company profits has not resulted as productivity and production have both fallen. In fact, U.S. oil exploration and production companies are expected to spend more on drilling rigs in 2006 than they did in 2005 (up 28%) as spending on drilling rigs continues unabated.

Figure 28

Data: The Original E&P Spending Survey by Lehman Brothers, June 22, 2006

Supporting the strong fundamentals of the demand for drilling rigs outstripping supply comes from the inflation rates for drilling equipment and services. When adjusted for inflation, the oil industry's investment increased by only 5% between 2000 and 2005 according to the IEA. I commented on this in "Housing Slowdown Continues Though Consumer Confidence and Manufacturing Hold Steady" and provided my previous commentary below:

An interesting article was published in the Wall Street Journal (WSJ) on November 8th regarding oil industry investment, Investment by Oil Industry Stalls, 11/08/2006 (subscription required). The article commented on data compiled by the International Energy Agency (IEA) which showed that investment in the oil-and-gas industry was $340 billion in 2005, up 70% from 2000. What was interesting was that, remarkably, inflation accounted for nearly all of that increase. When adjusted for inflation, the oil industry's investment increased by only 5% between 2000 and 2005 according to the IEA. This lack of true capital investment will lead to moderate increases in supply instead of large incremental increases that often quench bull markets in rising energy prices.

Figure 29

Source: WSJ

Bhushan Bahree, author of the WSJ article, provided the following commentary on findings in the IEA 2006 World Energy Outlook.

If world demand for oil rises faster than projected, or if production-capacity gains are less than expected, the result would be upward pressure on prices. But even if demand-and-supply trends conform to projections, which is unlikely, the oil industry's investments won't significantly add to the world's spare oil-production capacity, a buffer that is needed to offset supply disruptions that periodically occur because of political, natural or industrial upheaval.

Oil prices nearly doubled between 2000 and 2005, leading to a gusher of revenue and profits for oil-producing countries and companies. Among the reasons for the sharp price increase was the industry's inability to increase production capacity to match the surge in demand. That was the result of self-imposed investment restraints during the industry's lean years in previous decades, when oil prices crashed twice because of excess supply.

From 2000 to 2005, world oil consumption rose 9.3% to 83.6 million barrels a day, testing the world oil industry's ability to produce and refine so much petroleum.

The industry has faced fierce inflation in recent years, with the cost of items from cement and steel to drilling rigs and services soaring because of global demand. Among oil projects taking a huge cost hit was Royal Dutch Shell PLC's massive undertaking in Sakhalin, in Russia's far east. Investment needed for this project rose to $85,000 per barrel of oil-production capacity from the originally planned outlay of $50,000 a barrel, Mr. Birol said.

The inflation mentioned in the article that makes up nearly all of the $340 billion spent in 2005 can be clearly seen when looking at the inflation rate in oil field and gas field machinery contained in the PPI report. The inflation rate for oil and gas machinery is running at double-digit inflation rates despite active rig counts at levels not seen in over 20 years. Until a surge of real versus nominal capital investment by energy companies is seen, any incremental supply for crude oil will likely be met by incremental increases in demand from China and India, meaning the fundamental bull market in energy is alive and well.

Figure 30

Source: Moody's Economy.com Data: Baker Hughes Incorporated, U.S. Bureau of Labor Statistics: Producer Price Index (PPI)

Not only is the fundamental picture for oil a strong case for long-term investing in energy, but so is the value that lies within the sector.

Value

For the sake of not reinventing the wheel and saving time, I wrote previously on energy valuation in a Observation titled, "Value Still Lies Within Energy: Disbelief Leaves Room for Modest Multiple Expansion"and included that piece below:

Every decade has its investment theme where one asset class or sector outperforms its counterparts. There are different reasons for this, such as the economic environment at the time, whether the period was characterized by inflation or deflation, monetary tightening or easing, or liquidity contraction or expansion, as well as technological advancement.

What characterized the investment background of the 1970s was inflation as seen by the chart below, which shows rising bond yields and a corresponding rise in commodities as reflected by the CRB Spot Index.

Figure 31

Source: CRB & Federal Reserve

In this type of environment the best performing sector was oil as shown by the chart below. Oil was the best performing sector going into the mid-cycle slowdown in 1974-1975 and was off to the races as the decade ended, finishing up with a 250% return for the decade.

Figure 32

Source: http://www.gummy-stuff.org/sector-returns.htm

In the 1990s technological advancement was the predominant theme, with the chart below showing technology shares surging and outperforming all other sectors by a large margin, with a return of more than 1000% (chips) by the end of the decade. Note that like the 1970s, the period was characterized by a mid-cycle slowdown with the bulk of performance coming in the later half of the decade.

Figure 33

Source: http://www.gummy-stuff.org/sector-returns.htm

The second half of the 1990s saw a significant expansion in price-to-earnings (P/E) in all sectors, with the greatest expansion seen in technology shares with the average forward P/E rising to a peak near 50 in 2000. The P/E expansion reflected the pouring in of funds that drove up the price of technology shares faster than earnings were rising and thus expanded the P/E ratio.

In contrast to technology shares, oil & gas stock prices did not keep pace with earnings growth and their P/E ratios actually contracted to single digits instead of expanded during this decade.

Figure 34

Source: BCA Research, U.S. Equity Sector Strategy

In the latter half of the 1990s, computer and electronic inventories built up as shipments could not keep pace with manufacturing. Technology shares closely followed the shipments/inventory ratio, as seen in the chart below.

Figure 35

Source: Census Bureau (Factory Orders)

As the economy cooled and shipments slowed, technology shares corrected in 2000 and the inventory glut in computer and electronic products began to work off.

Looking into oil & gas inventories sheds some light on whether energy stocks have indeed peaked. Though energy inventories have risen, they are still below levels seen in 1998 and 2002 and are not excessive. This is especially true as global spare capacity is thin at the same time global oil production has been on the decline.

Figure 36

Source: BCA Research, U.S. Equity Sector Strategy

Global economic growth remains strong with China and India representing the bulk of increasing demand for energy, commodities, and machinery as their economies continue to develop. Despite media opinion to the contrary, there is no sign of slowing of China and India's economies as seen by the machinery inventory to shipments (I/S) ratio. The surge in China and India's economic growth can be seen in the chart below, with the machinery I/S ratio falling to record lows.

Figure 37

Source: Census Bureau (Factory Orders)

Due to the strong demand for machinery in developing nations, the I/S ratio continues to fall while the backlog for machinery makers like Caterpillar (CAT) continues to climb, not to mention CAT's stock price.

Figure 38

Source: Census Bureau (Factory Orders)

Returning back to investment themes, as in the 1970s, the oil & gas sector has been the star performer this decade. As oil & gas prices have surged, so too have oil & gas company sales with the energy sector posting sales growth of more than 250% by 1st Q 2005, with consumer staples coming in second, with less than 150% growth in sales since 2000.

Figure 39

Source: Aggregate sales of top ten market cap stocks in each sector normalized to 2000 sales,
as cited in annual reports

Like the 1970s mid-cycle correction in oil stocks, the current correction likely presents an attractive entry point for the next run out to the late decade which may dwarf the returns seen in the first part of the decade if energy shares experience an expansion in their P/E ratio. The latter part of the 1990s showed not only a P/E expansion in technology shares, but also other valuation multiples like the price-to-cash flow (P/CF) and price-to-sales (P/S) ratio.

Figure 40. S&P 500 Information Technology Index P/S and Standard Deviation Bands

Data Source: Bloomberg

Figure 41. S&P 500 Information Technology Index P/CF and Standard Deviation Bands

Data Source: Bloomberg

As seen in Figures 40 and 41, with the final run in technology stocks in the latter part of the 1990s the S&P 500 IT index's P/S and P/CF moved in lockstep fashion with the index's price. By the end of the decade the valuation multiples exceeded more than one standard deviation above the mean and sharply corrected back toward the mean with share prices following suit.

Like technology shares, energy stocks' valuation multiples reached overvalued territory by the end of the 1990s, exceeding more than one standard deviation above the mean and corrected sharply. What is different with the energy shares valuation contraction relative to that of technology shares after 2000 was that technology share prices fell much faster than earnings did, driving down valuation multiples. In contrast, energy share prices did not correct as much as earnings rose to compress valuations. This can be seen when looking at Figures 40 and 41 that show technology shares (black line) falling sharply along with their valuations while Figures 42-44 show the S&P 500 Energy index (black line) correcting modestly at the same time valuations dropped sharply due to a rise in earnings.

Figure 42. S&P 500 Energy Index P/BV and Standard Deviation Bands

Data Source: Bloomberg

Figure 43. S&P 500 Energy Index P/CF and Standard Deviation Bands

Data Source: Bloomberg

Figure 44. S&P 500 Energy Index P/S and Standard Deviation Bands

Data Source: Bloomberg

As seen in Figures 42-44, whenever the S&P 500 Energy index's valuation multiples neared or exceeded one standard deviation above the mean a correction occurred. Likewise, valuation multiples near or exceeding the lower standard deviation from the mean were attractive entry points as shares soon advanced. Looking at Figures 42-44 show that all three current valuation multiples are near the lower standard deviation bands, not to mention at levels not seen since the beginning of the bull run in energy stocks in 2003.

Some of the structural and fundamental underpinnings of the oil industry may sustain the bull market in energy for years to come. Unlike the past where shortages were created by manmade actions like war and oil embargoes, the current situation is due to demand outstripping supply.

Charley Maxwell, senior oil analyst from Weeden & Co, who has been in the oil business for almost 50 years provides the following commentary from a Barron's interview conducted by Sandra Ward entitled, "Oil Prices: A Pause, Then Up":

We often say there are not a lot of advantages to getting old except that we have seen it all before. After a big move upward, there is always some counterreaction. We saw it during the 1973-74 crisis, in the '79 to '86 crisis and then in the two wars with Iraq. These crises were manipulations of the oil market by human beings. War, economic problems, but particularly military considerations, were creating, as they say, facts on the ground that worked into shortages that were real, but they were shortages created by the actions of man not nature. It is terribly important to differentiate between past periods and now.

[-] What came out of the 1986-1987 collapse in prices was a huge overcapacity of about 20% in the world's oil production system. The international oil companies began to adjust their capital spending quickly to adapt to that and they more or less serviced a 1% increase in demand each year. The capacity surplus began to come down naturally. We have now had 20 years and taken that surplus down to about 2% to 3%. For efficiency in the energy industry, given the weather factors and political factors and so on, we need something in the 7% to 8% range of excess capacity in order to cover the mountains and the plains of demand and weather and political events. But when the surplus got down to those levels between 1997 and 2000, the companies didn't add to capacity at a fast enough rate.

[-] We are now getting a reaction to the higher oil prices. It is translating into slower economic growth and, of course, it is allied with a rise in interest rates. Don't think that it is just that rising oil prices equal lower economic growth. It is a question of rising oil prices and less liquidity and higher rates that's a triple threat. The bottom could be in the high 40s, though that wouldn't be sustainable. On a yearly average, we will stay in the 60s, but we'll spend a lot of time in the 50s. Then they'll start up again in 2008-2009 and go up for some time. When we get to 130 or 150 there will be another pullback.

[-] In 1930 we found 10 billion new barrels of oil in the world and we used 1.5 billion. We reached a peak in 1964 when we found 48 billion barrels and used approximately 12 billion. In 1988, we found 23 billion barrels and used 23 billion barrels. That was the crossover when we started finding less than we were using. In 2005, we found about 5 billion to 6 billion and we used 30 billion. These numbers are just overwhelming.

Conclusion

With China and India still growing at an astonishing pace, global oil production in decline, global oil spare production capacity thin, OPEC cutting production, oil inventories not excessive, and energy valuation multiples at bargain-basement levels, investors may well be rewarded by purchasing energy shares under these conditions as the energy sector is likely to be one of the biggest manias of the decade.

TODAY'S MARKET - Economic Reports

International Trade

The trade balance for November was $58.2 billion, below the consensus call for $60.0 billion, narrowing by $0.6 billion or 1.0% over October's $58.8 billion number. Contributing to the narrowing of the trade gap was growth in exports rising more than imports, with the trade gap with China falling 6.3% to $22.9 billion. The trade deficit with China did not narrow by a surge in exports to China, but with imports from China in the U.S. falling faster than exports to China, a potential sign of falling U.S. consumer demand as the economy slows.


Source: Dismal Scientist, Data: Bureau of Economic Analysis/Census Bureau

The trade deficit with China wasn't the only deficit to narrow as the goods deficit with Europe and Japan both narrowed. Like trade with China in November, the narrowing of the trade gap with Europe came from exports falling to a smaller degree than imports, with exports dropping by 0.9% and imports falling by 2.7%. On a year-over-year basis, the trade deficit is down 9% with exports rising 13% and imports rising by 5% as the U.S. consumer slows consumption and energy prices weakening with petroleum imports falling in November to $20.2 billion, down 9.4%.

MBA Mortgage Applications Survey

The volatility in the mortgage industry continued as mortgage demand increased 16.6% last week after recovering from the 14.2% plunge during the week of December 22, 2006. Purchase applications rose 16.2% with refinance applications rising even further, up 17.3% last week. The increase in mortgage demand likely came from a drop in mortgage rates which were down last week. The contract rate on the 30-yr fixed rate mortgage (FRM) fell nine basis points to 6.13% with the 1-yr adjustable rate mortgage (ARM) declining five basis points to 5.79%.


Source: Dismal Scientist, Data: Mortgage Bankers Association of America

Oil & Gas Inventories

Crude oil sold off today with the release of oil & gas inventories as a sharp rise in distillate and gasoline stocks was seen last week. Crude oil inventories fell sharply by 5 million barrels in stark contrast to an expected rise of 820,000 barrels. This was partly due to consumption of refiners of crude to produce distillates and gasoline which were up dramatically, rising 5.4 and 3.8 million barrels respectively.


Source: Energy Information Agency (EIA)

For excellent and insightful commentary on oil, distillates, and gasoline supply/demand developments and trends, be sure to read the summary provided by the EIA (click here).

The Markets

The stock markets fell in early morning trading before staging a mid afternoon rally to finish marginally positive aided by a strong fourth quarter earnings report from Alcoa (AA), whose earnings rose 60% from stronger demand and prices, and an increased bid by US Airways for Delta Air Lines Inc. to $10.2 billion, 20% higher than its previous bid.

The Dow posted a decent gain of 25.56 points to close at 12,442.16. The S&P 500 was up 2.74 points to close at 1414.85, and the NASDAQ put in a decent showing on the strength of Apple Computer Inc., rising 15.50 points to close at 2459.33. Investors sold Treasuries today with the 10-year note yield rising to 4.682%, up 0.56% by rising 2.6 basis points. The dollar index also posted a gain on the day, rising 0.34 points to close at 85.09. Advancing issues representing 49% and 48% for the NYSE and NASDAQ respectively, with up volume representing 56% and 71% of total volume on the NYSE and NASDAQ.

Energy commodities were down on the day as traders sold crude after the release of U.S. oil and gas inventories. The sell off in energy pulled precious metals down with gold falling $2.30/oz to $611.40/oz and silver falling $0.1350/oz to close at $12.365/oz. In contrast to precious metals, base metals were mostly up on the day with tin and copper leading the pack, up 3.73% and 3.07% respectively.

Overseas markets were predominantly down with Japan's Nikkei and China's Hang Seng indices posting the largest declines, down 1.71% and 1.66% respectively. Latin markets put in the best showing with Brazil's Bovespa index and Mexico's Bolsa index rising 0.78% and 0.40% respectively.

Nearly all ten S&P 500 sector performances were up today, with energy being the lone sector in the red after a bearish inventory report. The technology sector was the biggest winner on the day with on the back of a two day rally in Apple Computer Inc.

Chris Puplava

© 2007 Chris Puplava

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