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Leonard Brecken

Leonard Brecken

Leonard is a former portfolio manager and principal at Brecken Capital LLC, a hedge fund focused on domestic equities. You can reach Leonard on Twitter.

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Did The Fed Intentionally Spark A Commodity Sell-off?

Did The Fed Intentionally Spark A Commodity Sell-off?

The intention here is the bring facts to light so the public can decide.

I’m not quite sure what to believe on how and why oil prices remain more than 50 percent below free cash flow break even for most independent E&P companies. I know for sure it’s not just one reason and is more likely a confluence of events.

Part of the reason oil prices broke new six-year lows is tied to hedge funds shorting equities and pressuring equity pricing through shorting oil. Another reason is the desire of private equity firms to buy assets on cheap and some banks seeking M&A fees. Obviously OPEC policy has a part to play. There is also no doubt that EIA statistics mistakenly leave the impression that production has remained resilient throughout the summer. But the spark that set the ball in motion was the dollar strength as every major money center bank in the U.S. recommended going long EU equities and long the dollar because of further monetary easing in Europe. Related: How To Profit From Crashing Oil Markets

The inverse correlation between the U.S. dollar and oil prices in June was virtually 100 percent, but that has changed more recently, as I have noted previously. At that time, investors here in the U.S. plowed into biotechnology and technology and went short oil as if they knew what assets central banks were going to buy and not buy based on all the free money from Europe and Japan.

Since the financial crisis began the cozy relationship between money center banks and the Federal Reserve, since the bail outs, is well known. For example, Goldman Sachs’ deep ties to the U.S. government are notorious and, not surprisingly, they led the charge in calls for a downturn in oil. So has the media, as I have extensively documented all year here.

On the other hand, oil inventories on paper in the U.S. were rising into the fall of last year for sure while the economy was weakening in the U.S. and in China, the largest importer of commodities. So the merits of weaker commodity prices stand on their own to an extent. The correction to $70 from $100 was justified, but the crash to levels not seen since the crisis of 2008-2009 are overblown. Now the cries comparing the 2015 crisis to the 1986 oil demise rise as well. Are economic conditions that bad? Related: Could The ‘Fusion Engine’ Become a Reality Before 2020?

For oil, demand has greatly accelerated, in fact. Then why go long the riskier, higher beta technology that, at their highs and still to this day, are still being pumped? To make matters worse, record short positions in oil futures and equities still exist, eclipsing even the 2008-2009 meltdown. So where did this long tech, short commodity trade derive from and why? One possibility is the Federal Reserve itself; either indirectly, through monetary policy, or directly.

When the markets corrected last fall, Fed officials did not shy away from additional use of monetary policy or Quantitative Easing (QE). The cries from Wall Street were as loud as ever for it.

By early 2015, the economy had weakened, and GDP dropped below 2 percent growth on an annual basis. But Wall Street’s cries were largely silent, other than to say the Fed shouldn’t raise rates. The Fed, on the other hand, instead of threatening to ease, is instead threatening to tighten; the opposite of what we heard when markets fell similarly in 2014. The question is, why the change, despite fundamentals weakening?

One theory is that some within the Fed realized that QE wasn’t working, and never worked, thus another path was needed. But what alternative did they have, since rates were already ZERO? Related: Why Saudi Arabia Won’t Cut Oil Production

So maybe they changed course and took a strong dollar policy vs. a weak one to intentionally weaken the commodity sector and thus boost consumer spending. Throughout this down turn, that message has been repeated by Yellen herself many times, as a source of economic stimulus and for sure has been repeated over and over in the media and the talking heads of Wall Street.

Wall Street is notorious for not fighting Fed policy, so they turned to other asset classes such as technology to blow that bubble up even further. But then why was there such a desire to close the Iran deal so suddenly, which would further add to global oil supply?

This theory isn’t as farfetched as it initially seems, especially considering that Wall Street has been investing based on central bank policies for 6 years now, moving money where easing occurs around the globe and putting very little into real fundamentals. It’s something to consider in explaining prices.

By Leonard Brecken of Oilprice.com

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  • Bob on August 27 2015 said:
    An interesting and plausible idea that amounts to a conspiracy involving the Fed, banks, and perhaps even OPEC. It also provides a rational for the Feds strong USD, in the face of even stronger criticism from a number of world famous economists. I'd like to hear more.
  • gtatar@shaw.ca on August 27 2015 said:
    Intentionally, probably not, but they've definitely accelerated the sell off.
  • Peter on August 28 2015 said:
    The petrodollar has worked since the 70's by forcing oil consumers to pay exclusively in dollars, thus keeping massive amounts of dollars sloshing around abroad from getting dumped and the $ crashing.
    $80-100 oil interferes with this policy, when every Tom, Dick and Harry can frack his own oil. So it was decided that the only way to save the petrodollar is by lowering oil prices, remove a good part of the fracking supply and get back to the old system of oil only for dollars, albeit at lower prices, from a few suppliers that need protection from Uncle Sam. Who needs another Yom Kippur War to remind them of that?
    An agreement with Iran would perfectly fit into this scheme. Watch them sell oil only for $.
    Sorry for the fracking and shale industries, but the $ is more important, said the money printers. They want order in this world. Their order. Netanyahu tantrums notwithstanding.
    One fly in their ointment could be the rapid and near miraculous lowering of the cost of fracking, and if the money printer gambit doesn't work, they would only have war left to protect their interests.

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