Prices steady as Europe continues to evolve

(CME Group) – The markets have been all about the evolving debt situation and potential solutions in Europe which will remain the number one macro driver for yet another week. The EU leadership ended their weekend summit pretty much the same way they started the summit …without a consensus driven solution and plans to get it done by the end of the newly planned summit on Wednesday. The problems have been lingering in Europe for over two years and I am not sure why it has been a big struggle to bite the bullet and solve the debt problems one way or the other. I am also not sure what revelations are going to occur in the next few days that have not already been discussed many times over. That said the markets are willing to wait and see if the EU leadership can finally get their act together. Most risk asset markets are steady so far this morning after a relatively strong end to last week.

While the world’s asset markets remain somewhat hostage to Europe the macro economic data that has been hitting the media airwaves has mostly been better than expected including the strong recovery in the preliminary HSBC Manufacturing Purchasing Managers Index out of China overnight. The Index increased to 51.1 in October from a final reading of 49.9 in September. The manufacturing sub-index rose to 51.7 in October…a six month high compared to 50.3 in September. Anything over 50 indicates an expansion in the manufacturing sector. Although the developed world economies (US & Europe in particular) are still sluggish at best the emerging market world…the main growth engine for oil and other commodity consumption is starting to come to life again as evidenced by the preliminary HSBC data on China as well as the 2.4% increase in Japanese exports for September (in spite of the surging Yen of late).

If the European leadership can finally come together and agree to a long lasting and durable solution to their debt problems market players may start to view the global economies as having some upside or expansion potential especially since the macroeconomic data has not been as bad as it was just a few months ago. If the market becomes convinced that there will not be any major defaults we could see the beginning of a demand driven perception rally much like what occurred back in the first half of 2009.

Although we are at the end of the tropical weather season there are two weather events that warrant putting on the radar. Tropical Storm Rina formed over the weekend and is expected to strengthen to a hurricane by the end of the week as it passes northward along the eastern coast of the Yucatan with the potential to wind up in the Gulf of Mexico sometime next week. It is still too early to determine whether or not it will become a threat to the oil and Nat Gas producing operations in the Gulf and as such it is still a watcher and not something that warrants any price defensive action at this stage of its life. There is also a wave just south of the Windward Island that has just a 10% chance of strengthening over the next forty eight hours. For now we remain in a watching pattern rather than action pattern.

When the dust settled and the end of the week arrived most all risk asset markets were still in negative territory but were able to recover a major portion of the losses from earlier in the week when the market quickly became disappointed with progress in the EU after the G20 meeting a week ago. The action and volatility last week was in all of the oil and commodity markets as well as the global equity markets. Last week was all about market players acting around the cloud of uncertainty that continues to engulf all risk asset markets. However by the end of the week there were some signs of an easing of the fear and panic with a view that the evolving sovereign debt issues in Europe may be solvable with that sentiment holding (so far) to start this week as the markets are being driven by more confidence for a solution in Europe by the Wednesday summit in Brussels. Equity bourses were mixed as uncertainty decreased around the global economy. Precious metals declined modestly even as cash headed out of the US dollar.

Over the last week the oil complex was mostly lower with WTI the only oil commodity in the complex to end the week with a gain. WTI increased about 0.46% or $0.40/bbl. The Dec Brent contract ended the week with a loss of 2.38% or $2.67/bbl. The Dec Brent/WTI spread declined modestly as the inventory situation in the US continues to improve (improve defined as destock) and with the demise of Gaddafi the likelihood of Libyan oil flow continuing to recover is now a higher probability.
On the distillate fuel front the Nymex HO contract decreased even as distillate fuel inventories decreased versus an expectation for a modest build while US distillate fuel exports continue to increase. Spot Nymex HO decreased by 1.25% or $0.0383/gal. Gasoline prices also decreased on the week even as gasoline stocks declined strongly versus an expectation for a modest build. The spot Nymex gasoline price decreased by 4.96% or $0.1401/gal this past week.

Nat Gas surged higher earlier in the week only to lose some of its upside momentum by Friday. On the week Nat Gas futures lost 2% or $0.074/mmbtu. For the first time in three weeks it was not a buy the rumor, sell the fact trading pattern as Nat Gas prices were driven by an underperformance of last week’s injection report versus the expectations (only). So those coming into the report short the market was given a very big surprise when the injection level was at the lower end of the expectations but still greater than both last year and the five year average for the same week. Not much has changed in the overall picture in that a big surplus is now in place versus the five year average and the gap versus last year is now down to just 1.3% and still on a path to hit the all time record high if not exceed it prior to the start of the upcoming winter heating season. There is still at least another month or so left to the injection season there is no doubt in my mind that the gap will be eliminated.

On the financial front equity markets around the world ended the week mixed. Fear of contagion coming from the southern EU member countries… although still a huge concern in the financial markets… eased a bit toward the end of last week along with a view that the US economy could possibly be starting to show some early signs of stabilizing. However, global equity values decreased as shown in the EMI Global Equity Index table below mostly driven by uncertainty & fear.

The EMI Index lost 0.3% on the week keeping the Index below the bear market threshold level of 20%. The EMI Index widened its year to date loss to 16.4% with the US Dow now back to showing a gain for 2011. The US Dow is still in the top spot of all of the ten bourses in the Index while eight of the other nine bourses are still showing double digit losses for the year. Last week the global equity markets were a modest negative for oil prices as well as the broader commodity complex.

The US Dollar Index declined slightly on the week as some confidence came back into the euro which was about unchanged on the week. Cash that was hiding in the safe haven of the US dollar started to slowly flow back into selected risk asset markets (at the very end of the week) around the world with oil and global equity markets at the top of the list. The currency markets are still in the midst of a major realignment as I have been warning for months. Cash flowed out of gold (and the rest of the precious metals complex) which decreased by 2.78% on the week.

Even WTI still trading above the $85/bbl level I have to keep my view at neutral with a bias to the bullish side as it seems as of this writing that the ability for the Europeans to solve their debt issues by Wednesday is a possibility. If it is solved the markets will react positively and there will be a relief rally. If not keep your seat belts fastened. As the market is poised to react based on the outcome in Europe the risk/reward of being in the market is not very favorable. Once the outcome is know there will be ample time to get back in.

Although I am still bearish I do not expect Nat Gas prices to move back and follow the downward underlying trend in the very short term (next few days). The fact that the spot futures contract closed above resistance suggests the market may try to move higher in the short term. As such I am moving my guidance to neutral to see how price activity plays out over the next several trading session.

As I have discussed on several occasions the market is always telling us what to do. The Nat Gas market was telling us it did not want to go lower over the last week or so and as we saw last week the lower than expected inventory injection was the reason the market was signaling. Although I do expect total inventories will hit the all time high I am also starting to expect the magnitude of the over performance of forward injections to narrow (as we saw last week). As such we may not get a new test of the $3.40/mmbtu support and it is possible that the lows of the shoulder season could be in for now. For those buy side hedgers it may be time to start adding to your winter hedge portfolio.

Dominick A. Chirichella | dchirichella@mailaec.com
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