Crude head fake means lower prices ahead likely

Crude oil has had quite a slide since July of 2014.  Recently it appeared as though prices may be stabilizing, but recent price action may suggest that what seemed to be a double bottom may actually have lead to a head fake rally rather than a durable price support level.

crude oil pricing

US crude oil spot price chart from the last 6 months.

With a firm rejection at the 50 day moving average, and the bollinger bands widening, it seems that on a technical basis crude is poised to take out its lows.  Is a $30 even $20 in the cards?  Possibly.  Crude traded as low as the mid $30s back in early 2009.  We could see similar price action in a capitulation event or a slow grind down.  There is not enough conviction for a significant price breakout without increased demand or a geopolitical event threatening oil production.

 

What’s Yelp’s review service worth to investors?

Yelp illustrates just another social media bubble reverting to the mean. The premise of this company is that it unites people with great local businesses.  And maybe that actually happens on occasion.  But today investors are increasingly skeptical of this company’s value.

YELP stock

Yelp’s stock crashes 20% on earnings that exceeded expectations.

How does Yelp operate?

Yelp’s position is to try to offer reviews that help consumers make informed decisions about the companies they engage.

The problem is the 1-9-90 situation that Yelp currently finds itself within.  One percent of reviewers are active, 9 percent occasionally review and the rest are simply viewers.

Without any transparency, how can there be trust?

Adding validation of identity, a business transaction or a check-in at the location would likely impact those numbers negatively. And that, in turn, would potentially hurt site traffic and advertising revenue.

But doesn’t having some ability to say, yes, in fact this person did engage this company for this service, provide credibility?  As of this moment the only credibility Yelp has is built off the reputation of the site.  And that seems to be dwindling as more become aware of the ongoing shenanigans.

If Yelp is not willing to go beyond providing anonymous reviews about business relationships that may have never occurred, which then potentially cause real world pain to hard working companies, then I’m not certain that Yelp really provides any value to the local businesses it claims to serve.

Yelp’s ad-driven profit engine is questionable at best

After reviewing how the pay per click advertising system works on Yelp I’m quite disappointed to see that the majority of ad placement occurs in non-related categories or outside of key geographic regions.  Essentially it looks like ads are foisted wherever they can be without attention to applicability.

So what’s the the bottom line on Yelp?

What is a company that provides at least 20% (according to Yelp’s own numbers) false reviews really worth?  Is it net beneficial or harmful to the local business community?  Can it be readily replaced by a service with more credibility and a stronger emphasis on transparency?  Will users continue to utilize this service with Google and other more established companies providing alternative ratings services?

Apparently today investors in Yelp’s shares are asking themselves the same questions.  With a P/E of close to 2,000 one can reasonably guess that the path of least resistance is down.  My personal estimate is a reversion to the post-IPO pricing of about $20-25/share.

Quick thoughts on 2015

This is likely going to be a year of reckoning for overvalued equities and corporate bonds.  The credit markets have already begun their contraction, but equities hold on to the promise of earnings expansion, while only truly achieving multiple expansion.  Stocks are far too rich in price vs. the underlying economic global backdrop.  I expect a significant correction, and I expect it to occur during (or before) Summer.

Copper’s crash confirms global economic rout

Copper, the commodity often hailed as a prognosticator of future economic trends, is tumbling 8% today, after shedding more than 4% yesterday.  Prices have not seen these levels in over 5 years.  The weakness is attributed to a lack of conviction among speculators by reports circulating the media.  I hazard to guess that the real reason copper has been plunging has more to do with a lack of demand.

As goes copper, so goes the world?

copper

Copper is used in infrastructure projects, for electronics and a variety of industrial applications.  Weak demand is an indication that manufacturing is dwindling.  Such a slow down would be a confirmation that our earlier call for deflation is playing out and we may see further economic and financial market weakness to come.

In fact, it is becoming quite likely that the world realizes all of the recovery since 2009 has been predicated on stimulus and liquidity, rather than resolving the underlying economic and debt imbalances.

Higher stock market volatility may be persistent in 2015

A recurring theme in the bull market rally since 2012 has been minimal volatility.  The days of enormous whipsaws in price were seemingly behind us until late 2014.  The mood of the market has decidedly changed as of late.  What used to be a complacent, calm and somewhat orderly march in to parabolic territory has degenerated in to a much more unpredictable series of widening trading ranges.

Watch for a potential trend change

As volatility increases, there is the potential that fear will overwhelm greed and the bulls will become more concerned about securing profits than taking risk.  Margin levels are off the chart and short positioning is still historically low, so downside momentum may hasten quickly if it is perceived that an interim top is forming.

Volatility index (VIX)

If such a change occurs, it is likely that we will see a long overdue correction occur in the broader equity and lower tier credit markets.  It also may prompt an exit from the crowded long dollar trade if the risks are perceived to be domestic.  2015 holds plenty of promise for interesting global and financial market developments.  Stay close to the news feed and price ticker.

The crude contagion could cause chaos, crash

On the heels of another massive sell off in crude oil, the US stock market woke up from its slumber.  Instead of the discount in crude oil being priced in as a stimulus, it was seen (perhaps more accurately) as a risk. Crude touched prices that had not been seen since April, 2009.

US equities sold off on higher than average volume, with bonds, gold and silver catching a bid.  The VIX showed fear entering the market and spiked higher, but the rally faded as the day went on.  The US dollar strengthened modestly on the back of a weaker Euro and Yen.

Interest rates on the 10 year bond tested 2.00%, while gold has climbed above $1,200 and stabilized.  Tonight the Nikkei is selling off significantly in Tokyo.

crude oil

Greed may pause to give room for fear to take the reigns.

Markets are decidedly in a risk off mindset.  I suspect that this fear of risk will prevail over the leveraged and crowded long side bullishness that has pushed the US stock market up to record highs with few downdrafts over the last few years.

The fundamental improvements in the US economy have been sluggish, with many corporations buying back their own shares to boost EPS.  There is a dislocation between current perceived valuations and the global economy’s condition.

The crash in crude oil has brought about a serious challenge to many economies of energy producing nations, including the US.  Since 2008 many of the high paying new jobs have been in the energy sector.  Now that oil is down over 50% from its highs, many of these projects are no longer viable and drill rig operations are now at 10 month lows.

us oil and gas rigs jan 5 2015

Energy markets are an indication of economic health.

There is a certain amount of feedback from energy market prices that can be indicative of manufacturing activity, shipping and transportation.  To the extent that supply exceeds demand, prices should diminish until demand returns.  But even with a 50% cut in prices, there still seems to be room for more of a decline.  That is because while demand is diminishing, some oil producers are keeping or increasing supply rather than removing production.  This includes OPEC, Russia and Iraq, who stubbornly churn out more oil as prices lose support.

The perception becomes that a flood of oil is oversupplying the markets, but the reality is that demand has declined to such an extent that softening Chinese manufacturing demand has caused a ripple effect.  Most of the softening demand comes from Europe, China’s largest customer, coming to grips with a wave of economic headwinds.

This new normal, if we are to give it a name, is likely an indication of future global macroecnomic trends.

Global GDP 2015

Deflation strikes Japan and the EU.  Is the US next?

Persistent deflation is becoming a persistent theme.  Bond yields in Germany on 5 year notes hit negative yields.  Japanese bonds have fractional yields.  The US bonds seem to be ebbing lower and lower in interest rates in sympathy of the global deflationary pressures coming home to roost.

Are we going to experience a lost quarter century like Japan?  It seems ever more likely as the similarities are increasingly problematic.  A prescription of debt to solve debt-related problems.  Liquidity injections for structural economic problems show a lack of understanding from central authorities about what is wrong with our economy.

Nikkei stock index

Too much leverage, too many derivatives, too little transparency.

What the world needs now is more clarity about how far stretched the current system has become.  With over 700 trillion dollars of global derivatives, there is such an enormous amount of risk in opaque markets that a significant dislocation could cause another financial collapse.

None of the problems of 2008-2009’s Great Recession have been resolved at home or globally.  Instead the financial players that created the problem have now been given the reigns of the global economy and are leading us down a destructive path towards crisis.

The problems of the world will most likely come home to the US in 2015 and cause a profound impact on our economy and financial markets.  While it may not be apparent yet, I believe that the risks now are much greater than back in 2008-2009 and the ability of monetary authorities to mitigate those risks is impaired by the current and recent aggressive measures.

DerivMkt-BIS-Dec'87-Dec'10

Stay tuned in to the flow of news.  Interesting things may happen sooner than we expect.

Has gold finally bottomed?

Let me start by saying I think it’s hard for anyone to call a bottom.  Many experts do, and often they do so with the guidance of charts, fundamental analysis and other informed speculation.  I am no expert, but I do think we’re finally seeing a turn in the precious metals markets based on two critical factors.

The US dollar and gold have rallied together as of late.  This doesn’t often happen, especially at multi-year highs in the dollar.  But it has for the past couple of days.  And during very large US dollar rallies.  As you can see in the chart below, for the past six months when the US dollar rallied, gold and silver were sold.

US dollar chart

This is a convincing indication that the precious metals markets are looking beyond the myopic view of the US dollar index (which really only measures the Euro and Yen weakness/strength vs. the US dollar) and seeing that rising risks demand a safe haven.  It may also indicate that the US dollar rally is beginning to lose its luster.

We also saw that the tax loss selling last year did not push gold and silver to new lows, or break down the miners further.  This is a very powerful indication that sentiment bottomed out in the October/November bloodbath that was likely a capitulative event.

I am not ready to say that we are turning right now, but I do think that there is a good chance of it.  In essence, if the precious metals markets can look beyond the dollar, or better yet, the dollar can begin to give back its rally from late 2014, we will be in for a year of renewed strength in precious metals, and their miners.

US dollar short vs long

The US dollar trade is as crowded as a trade can get and so many are short Euros and Yen that any unexpected surprises will roil the forex markets.  But gold and silver are telling us that doesn’t matter.  That they can look beyond forex and see that the risks are strong enough to warrant a significant bid (and most likely short covering — we’ll see the COT tomorrow).

Gold chart (daily)

From a technical standpoint I’d like to see gold trade above $1,260.00 on a sustained rally (closing the week on Friday above that level would be critical).  Ideally this price action would occur by the close of the second week of January, 2015.  After that I believe we’ll see some short covering and less aggressive posturing from the sellers counting on another waterfall capitulation in prices.

If gold can make its way back to $1,400 by the end of the first quarter of 2015, then I do believe we’ll see the momentum chasers come back to the table and start driving prices higher through leveraged speculation.  This may also renew the appetite from Asian buyers for physical bullion as the low prices have turned from a positive to a perceived negative as of late.

Bernanke’s Bubble in Stocks and Bonds

Summary

Six years after the height of the financial crisis, we may be living in one of the most prolific financial bubbles in recent history.  Under Dr. Bernanke’s guidance the US Federal Reserve system expanded its balance sheet to about 4.3 trillion dollars, with asset purchases creating a disproportionate wealth effect in equities and debt-based financial instruments.

Despite this massive injection of liquidity, by and large the US economy has not significantly recovered. Yet the US stock market (with the exception of the NASDAQ) is at all time highs. This disconnection in equity prices vs. measurable economic recovery is the primary reason that I believe a bubble exists. In addition, the artificially low interest rate environment (see: ZIRP and QE) has also created an enormous bond market bubble as reflected in US treasury bond yields.

LFP Participation

The US workforce is languishing 

A quick glance at the US Department of Labor’s recent U3 unemployment data would have us believe that almost as many Americans are employed as had been before the Great Recession.  Unfortunately the Department of Labor’s U3 unemployment rate is based on the amount of Americans currently on unemployment benefits — not the number of Americans out of work.

The US Labor Participation Rate is at its lowest levels since 1978, indicating that US job creation is not sufficient to support widespread employment. In addition, the quality of new jobs being created is equally deficient, with lower pay being a prevailing theme.  One of the Federal Reserve’s mandates is maximum employment.  A mandate they seem to be failing to uphold when utilizing more objective measures of employment.

cci

Raw materials are rolling over

While equity markets re-test all time highs, commodities are sinking fast.  Traditionally weakness in industrial commodities and energy prices signal global economic weakness.  Since July we have seen that weakness accelerate as the sell-off in commodities prices took the CCI (a broad measure of commodities prices) to multi-year lows.  This is a powerful sentiment indicator.

Optimism about global growth would be expressed in higher commodities prices — as more orders for raw materials would increase demand.  Another mandate of the Federal Reserve is stable prices.  A cursory glance at the above chart shows we certainly don’t have stable prices.

usd

Stronger dollar, weaker world?

Part of the recent decline in commodities prices has been attributed to recent strength in the US dollar index, which is in its most basic form, a measure of the dollar’s spot value vs. the Euro, Yen and GBP.  There are other currencies in the basket, but none are quite as influential.  In essence, the US dollar currently signals that it is more favored than the Euro, Yen and GBP through its ascent towards 87.

As commodities are priced in dollars, it is expected that some weakness will occur if the US dollar strengthens, especially under the back drop of softening global demand.  But one must also question the utility of the current US dollar index structure — and whether or not such an index is relevant in a world that seems to be increasingly moving away from the dollar as the primary trade currency.

spx

Stocks surged on stimulus. Now what?

With the S&P 500 back above 2,000 and optimism among fund managers back to similarly lofty levels, it may be time to examine the US stock market with a degree of skepticism. There exists a very high probability that we are in a bond and equity bubble that was fomented by the US Federal Reserve system. And traditionally these bubbles deflate when policy makers begin to head for the exits.

With QE3 over, and no immediate sign of further stimulus in sight, as well as the Fed signaling that rates are going higher in 2015, perhaps we are closer to seeing this bull market mature.  After all, it’s been largely driven by liquidity injections and those have since ended.

sp-500-vs-federal-reserve-balance-sheet1

A direct connection: Fed assets and stock prices

The correlation here is uncanny. QE’s various incarnations have an incredibly potent effect on boosting US equity prices to all time highs.  Just about every dollar the Federal Reserve has injected in to the US bond and mortgage market has found its way in to US equity markets directly or indirectly.

Now that QE3 has ended, what policies will be utilized next?  Is the Japanese QE-to-infinity program going to be enough to generate a new carry trade that pops US equities higher?  Or are we finally witnessing the tail end of one of the biggest financialized bubbles in US history?  One that has brought bond yields to the lowest levels in decades whilst simultaneously inflating mortgage-backed securities (lowering interest rates) and equity prices.

treasury

Is this bond bubble ready to bust or is it signaling something worse?

Bond yields are an inverse indicator of the underlying asset price. That is to say, the lower the bond yield, the higher the paper price to buy that bond.  This chart illustrates US Treasury bond bubble in no uncertain terms.  With US government debt exceeding GDP, whilst simultaneously at all time low yields, there is something wrong with this picture.

Typically the higher the debt level, especially as it exceeds the GDP of a country, the worse its debt outlook becomes.  The only exception we’ve seen to this rule has been Japan, which has ‘enjoyed’ a 25 year economic malaise that was culminated by their very own real estate bubble.  The deflationary forces at work there have been keeping bond yields and economic activity pinned down for a quarter century.

Reading the tea leaves of macroeconomic data

Signs seem to be pointing to an intermediate term deflationary bias.  It’s likely that this situation will be greeted by more quantitative easing from central banks of developed countries around the world. Signals include a rocketing dollar, collapsing commodities, the Bank of Japan already engaging in record QE and the weaker EU countries slipping back in to recession or worse.  In addition, China’s miracle growth story seems to be concluding with a not so happy ending.

m2

Velocity of money sinks to lowest level on record

Worse yet, with all of the Fed’s easing and stimulus, the velocity of US money has been collapsing.  This is an indication of economic activity insofar as how fast money is changing hands. Generally during periods of strength the velocity of money will increase.  What we’ve seen since about 2002 has been just the opposite.  A marked decrease in the velocity of money across all measures to the lowest levels ever recorded.

NYSE-margin-debt-SPX-since-1995

Leverage and levitating stock prices

Margin debt on the NYSE (see above chart) is at record highs, and similar leverage is being employed across many equity and bond markets around the world.  That means that the level of debt-based risk taking now exceeds what we saw during previous bull market peaks and as such a reversal in psychology would be even more dangerous to stock prices.

A replay of 2008’s volatile panic selling of various asset classes is quite possible.  The level of complacency and leverage in financial markets is similar to where we were in the fall of 2007 before the financial system began to collapse.

Conclusion

Watch these trends carefully.  Further deterioration of M2 stock velocity, commodity prices and increased dollar strength will signal the increased potential for a renewed deflationary global recession.  If such a situation unwinds, and if equity prices are dragged down in sympathy, then I do believe the Federal Reserve will begin to reinvigorate its stimulus programs and we could see the pendulum swing back towards a more inflationary bias.

What remains a mystery is how the Fed will do so when it already possesses the biggest balance sheet in its history — and has largely failed across many metrics to remedy the economic problems that face the US.  Alternatively, if Bernanke’s Bubble is allowed to burst, the consequences will be catastrophic, not the least of which for the Federal Reserve and its balance sheet.