Has Oil Finally Bottomed?

As stated in past articles, the fundamentals are a minor part of asset appreciation these days, while Federal Reserve actions are the major part. Last Friday, this was on display, as one of the largest market reversals in history occurred, not based on fundamentals but on more QE hopes.

It’s fairly clear that with the poor jobs report on top of the plethora of weak economic data all year the U.S. is perilously close to recession. The Atlanta Fed now has 0.9 percent GDP growth in Q3 which will likely be too optimistic on top of EPS cuts recently by big brokers on S&P earnings for 2015 and 2016.

No one can deny that the economy is much weaker than generally perceived. Instead of markets selling off, which they initially did on Friday, they reversed, as individuals or machines who control the markets are now programed to trade not based on economic data, but on what that data will do or not do to influence the Federal Reserve. Virtually all economists were wrong this year on the state of economy and on the timing of a rate hike.

I have been steadfast all year, arguing that the economy has been weakening to a point that even if a rate hike were to occur, the Federal Reserve would be forced to ease again. Further, it appears increasingly likely that the Fed has shifted tactics to allow for the strengthening of the dollar, by allowing other countries to conduct monetary stimulus (Japan and the EU, for example) without easing further in response. The dollar has strengthened as a result. Related: Six Reasons Natural Gas Prices Are Staying Down

The Fed is resisting another round of QE because it knows it would further erode the standard of living of the middle class as we head into an election year. QE would only cause more inflation via commodity rises, a short term wealth effect and little, if any, sustainable growth.

The Fed’s strong dollar strategy has weakened the price for crude. The recent commodity crash has been a byproduct of slower growth, to be sure, but the Fed’s strategy since last summer looms large in the decline of oil.

At this point, this “strategy” has failed miserably. It has further weakened the economy and has done little to boost consumer spending, something that the media kept trumpeting all year long. Further the resistance of the dollar to weaken even in the face of overwhelming weak economic data also demonstrates something is rotten here. Related: Is Russia Plotting To Bring Down OPEC?

Regardless, the calls of a rate hike are not only waning but slowly those calls are leaning in favor of more QE. Initially these calls, given the Fed’s stance, were directed abroad. But eventually they will be directed at Washington once the latest GDP data comes out, as well as 3Q earnings reports demonstrate the weak state of economic growth.

The implications of a Fed reversal, at a time where demand for gasoline already remains strong, and with production and inventories declining, will be profound and violent. Oil prices will spike as the dollar falls further, wreaking havoc on economic growth.

I should note that commodity-led nations such as the Middle East, Norway and Australia are seeing massive pressure on selling dollars as they liquidate their wealth funds to shore up finances from oil’s fall. Those wealth funds, once added to QE, are now draining the system’s demand for dollar denominated assets. This has added further pressure on the Fed to act and reverse course because ultimately their “wealth effect” mandate is being eroded. Related: BP Spells Out What’s Wrong With Big Oil In One Chart

When all of this occurs remains up for debate as asset price distortions can take longer to occur when government meddling is involved. But the point is that it has begun, and not surprisingly oil prices have stabilized.

I would like to reiterate to all of the investors out there: most money managers are investing your money based on centrally planned policies, not on fundamentals. That game may work for a time but will eventually unravel as centrally planned economies usually fail to deliver sustainable growth due to government malfeasance. China is the exception only because of its massive size, stage of development and ability to use FX to its advantage. And even China is showing some pretty shocking weaknesses these days.

One last note. All of this is occurring as fall redeterminations are underway, which has been marked by many as the moment when E&P companies would go belly up. But once certainty emerges on who will be negatively affected and who won’t, shorts will have to cover their positons.

By Leonard Brecken for Oilprice.com

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