There are some very nervous bankers and others in the financial world awaiting the approval of the $US700 billion bailout from the US Congress and Government.

Amid uncertainty about the plan’s prospects, US cash funds and banks stampeded to safety, buying short-term government debt, selling commercial paper and withdrawing funds from the interbank market. As a result, the rates that banks charge each other soared, while yields on short-term Treasury bills plunged.

Now it seems the plan is headed for approval with: it has to be signed off by the rest of the two parties’ representatives, US Treasury and other regulators.

Republicans are refusing to agree to the scope and direction of the legislation and this could defeat it as Democrats say they won’t pass it without substantial Republican support.

President Bush held a meeting with Barack Obama and John McCain and others at the White House.

The legislation will go to the US House of Representatives tonight, our time, and the US Senate will meet on Saturday to debate and approve it.

But it needs consensus, and if that’s not apparent, then trading will be fraught tonight.

Wall Street kicked higher in anticipation; up 300 points at one stage, then down sharply, before rising at the end to be up nearly 200 points on the Dow. It closed before signs of a lack of agreement emerged in Washington.

Financial stocks rose 2.6% and were among the biggest gainers on hopes that the plan would unlock frozen money markets.

GE rose 4.4% even after the world’s fourth-largest company cut its third-quarter and full-year earnings forecast and suspended a share buy-back. It was GE’s the second earnings downgrade this year.

Escaping the bullish momentum, Washington Mutual, America’s biggest savings and loan plunged 25% to just $US1.69 on reports that regulators were struggling to broker the takeover of the company.

Oil rose, the US dollar was stronger (and the Aussie was back around 83.60 US cents) and gold weakened. US Treasury bond yields rose on the news.

Figures were released showing another sharp slump in new US home sales and industrial production. It was a reminder that the real problems remain and won’t be touched by the bailout plan.

Stockmarkets in Asia fell, especially in Japan and Australia, thought China’s were higher. 

Stocks in Europe were up in early trading and finished higher, with gains in the UK, France and London as news spread of the broad agreement on the bailout.

Money market rates in Asia’s biggest financial centres jumped on concern that the US Congress might hold up or water down the Treasury Department’s plan to bail out the financial system (or at least try to).

A cash freeze has gripped world financial markets as fearful banks hoard billions and billions of dollars and prefer to leave it on deposit with central banks and earn less than they could get from lending it to normal business and personal customers.

Not even Australia is exempt: our well capitalised banks were following suit and sitting on billions of dollars.

Banks around the world are refusing to deal with each other, or anyone else, so they are leaving tens of billions of dollars on deposit with central banks.

The drought has worsened significantly since the collapse of Lehman Brothers 10 days ago and still rising losses taken by bond holders and other investors.

Bank nervousness seems to have picked up from earlier this week as the progress of the US bailout proposal slows in the Congress.

If that proposal was to fail, markets would dry up and if there was to be a reason why the global economies slumps into recession or worse, it would be this cash drought. The money’s there, tucked away in cash management accounts and at central banks, but no one is willing to lend. There is no shortage of borrowers.

Central banks in the UK and Australia moved this week to try and ease the drought by moving to mop up the cash.

The drought has seen short term interest rates around the world rise sharply as banks choose to leave their money with the central bank, or invest in short term US Government treasury notes as the ultimate short-term safe haven.

Short term US treasury note rates have again fallen under 1% while short term US dollar (and some other currency) LIBOR rates in London has jumped sharply to levels seen in the dark days of early January.

The three-month US Treasury bill traded at 0.49% in New York overnight, down from 0.79% at the close Tuesday and 0.88% on Monday.

The demand for short term, security can be seen from the results of a huge US Treasury auction of $US34 billion in two-year bonds: demand was about normal for the moment at 2.2 times the amount offered. Market yields for the notes traded down to 2.02%,

In Australia yields on 90 day bank kills, the key short term funding source in the country, have risen to where they are higher currently than 180 day bills. It is normally the other way around. Spikes like we are seeing are signs of a cash shortage.

A cash freeze has gripped world financial markets as fearful banks hoard billions and billions of dollars and prefer to leave it on deposit with central banks and earn less than they could get from lending it to normal business and personal customers.

Not even Australia is exempt: our well capitalised banks are following suit

Banks around the world are refusing to deal with each other, or anyone else, so they are leaving tens of billions of dollars on deposit with central banks around the world.

The drought has worsened significantly since the collapse of Lehman Brothers 10 days ago and still rising losses taken by bond holders and other investors.

Bank nervousness seems to have picked up from earlier this week as the progress of the US bailout proposal slows in the Congress.

If that proposal was to fail, markets would dry up and if there was to be a reason why the global economies slumps into recession or worse, it would be this cash drought. The money’s there, tucked away in cash management accounts and at central banks, but no one is willing to lend. There is no shortage of borrowers.

Central banks in the UK and Australia have moved within the past 24 hours to try and ease the drought by moving to mop up the cash.

The drought has seen short term interest rates around the world rise sharply as banks choose to leave their money with the central bank, or invest in short term US Government treasury notes as the ultimate short-term safe haven.

Short term US treasury note rates again fell under 1% while short term US dollar (and some other currency) LIBOR rates in London has jumped sharply to levels seen in the dark days of early January.

The three-month US Treasury bill traded at 0.49% in New York overnight, down from 0.79% at the close Tuesday and 0.88% on Monday.

The demand for short term, security can be seen from the results of a huge US Treasury auction of $US34 billion in two-year bonds: demand was about normal for the moment at 2.2 times the amount offered. Market yields for the notes traded down to 2.02%,

In Australia yields on 90 day bank kills, the key short term funding source in the country, have risen to where they are higher currently than 180 day bills. It is normally the other way around. Spikes like we are seeing are signs of a cash shortage.

Three-month interbank offered rates in Hong Kong and Singapore have risen sharply as well (Hong Kong has just had a run on the Bank of East Asia on Wednesday, which frightened the market there).

Dealers said the three month rates (90 days) jumped past the levels when Lehman Brothers filed for bankruptcy and the U.S. government nationalized American International Group last week.

Three-month rates on yen loans rose to a two-month high and bill swap rates in Australia soared to the highest since August.

In China however, shares rose to a three-week high yesterday as parent companies continued to buy back shares of their listed subsidiaries after the central government made that move easier as a way of helping stop the market slump.

In Australia, banks kept $6.9 billion in their exchange settlement accounts instead of using it to lend to one another. That was the highest amount kept in the ESA at the Reserve Bank since the credit crunch started and it’s a sign the banks are fearful of liquidity risk, even with one another.

 

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And from Japan a nasty warning about the global slowdown.

Japan’s trade account dropped into a surprise deficit in August as high oil prices pushed up import costs, but more importantly, exports slowed to a trickle.

Apart from January, which usually sees low levels of exports because of factory closures, it was the first monthly deficit since 1982, when Japan was reeling from the aftermath of the second oil crisis.

But, more important was the bad news from the export account.

Shipments to the United States had their sharpest fall ever from the same month a year earlier.

Exports rose 0.3% in August from August 2007, compared to a forecast of a rise of 2.4%.

Japan’s exports to the United States fell a record 21.8% last month, marking the 12th straight month of annual declines, on sluggish shipments of automobiles and consumer electronics.

Exports to the European Union fell for the third month in four.

A 6.7% rise in shipments to Asia and an 8.8% rise in exports to Japan’s new number one destination, China (for the second month in a row), couldn’t offset the slump in exports to the US and Europe.

Japan’s economy contracted in the second quarter at its sharpest rate in seven years thanks to slowing demand from the US and Europe and there are growing fears that it will shrink this quarter to put the country into a proper recession.

And major car companies, Toyota and Honda chopped back car production and exports in Japan and in the US and Europe in response to the slow down. Toyota’s global output was cut by a substantial 17%.

 

The current weeks are oil markets a “traders market”. It means that it is the playground of short-term moves, high volatility, nervous players, and strong reversals. This is where smart traders can make a lot of money but where long-term investors are a bit lost. After a long period of clear trends, it is likely to be now a new phase of consolidation and rangy market.

As we mentioned in our last update (September 11), the main target for the 2-months decline on oil prices has been the 61.8% Fibonacci ratio of the 18-months bullish trend occurred between January 2007 and July 2008 (between points A and B on the chart).

Click to Enlarge

Oil prices have therefore declined by 38.9% between the historical high posted on July 11 and the recent low posted on the Fibonacci level at $90.4 on September 16 (point C). There are two contrarian forces that should struggle to determine the future price action. On one hand, the action plan decided by the US authorities to fight the financial crisis is likely to create new US Dollars. This will damage the Greenback’s current value and should symmetrically increase commodities prices (as the US Dollar has been negatively correlated with energy prices). On the other hand, the recession and slowing growth around the world contributes to decrease the demand on energy. A weak US currency and a lower oil demand are consequently being the key fundamental factors that the market will highlight.

In the mean time, the technical indications will remain the market’s best friends. The rebound started last week from the Fibonacci support has already brought the prices until $110 a barrel (a bounce back of 22% in only a few trading sessions).

The momentum and oscillator tools turned bullish. The RSI triggered a positive signal on September 17 when it crossed above its signal line, showing that the oversold configuration was over and that the buyers were now surpassing sellers. The MACD confirmed this 2 days later (last Friday) when it turned upward and crossed above it signal line. The Commodity Channel Index is also now well oriented. Those elements argue for a further rebound.

The next objectives are respectively $112, $119 and $126. Those levels correspond to the previous Fibonacci levels (38.2% at $112 and 23.6% at $126), while $119 is half the way of the recent bearish trend (between points B and C).

On the downside, the $90 area is still valid and is the main support of the current pattern. There is another support horizontal line around $85.

Let’s start with the largest oil producer of the non-OPEC countries - Russia. Long-term, Russia will continue to sell its huge oil and gas resources, filling its country’s coffers with hundreds of billions of dollars. Going forward, Russia will continue to flex its military muscle because Russia’s policymakers know that we won’t strongly protest as long as we can import their oil.

China will dance around the world investing in countries the U.S. deems unsavory and locking up their oil reserves for years to come. They’ll drill just a stone’s throw off our borders while we fight it out among ourselves.

Nuts like Chavez will nationalize their oil industries, and offer us a take it or leave it deal; stealing the billions of dollars of infrastructure development we’ve invested.

Meanwhile, OPEC is basically running the energy show for industrialized nations, or at least they did until recently. But still despite the recent skirmish between the Saudis and their counterparts at the meeting, OPEC will still meet and decide how much oil to produce…

I find it unfathomable that we’ve allowed these countries to decide the fate of the U.S economy.

If we’re going to change this, then we need to get on the ball. If I was in charge of our energy policy, I would be working towards an independent program. I would be convincing leaders to take another look at the untapped reserves we have a little closer to home…in the Gulf of Mexico, and off the east and west coasts.

However, sadly I just don’t see this happening anytime soon. We’re a little too complacent to change our old oil ways. But, looking to the future, as we continue to exhaust energy reserves around the world, we will usher in a whole new generation of cleaner, renewable alternative energy…

 

It sounds like more of the same from the past few weeks: sharemarkets rattled, financial stocks rattled and commodities on the slide. 

Well, it was up till Friday when it suddenly became a very different story.

And this morning, a switchback, with oil under the $US100 a barrel mark in New York trading early today as damage from Hurricane Ike wasn’t as bad as feared.

The US dollar fell Friday as the slide in the euro came to an end; the Australian dollar bounced a couple of cents; gold, copper and several other commodities rose and Hurricane Ike was the big influence.

But the big question was whether Friday’s bounce was due to Ike coming ashore and apparently not leaving too much damage to the oil and gas producing, refining and distribution facilities along the Texas coast between Houston and Galveston.

At least 13 refineries in Texas were shut for the passage of Ike.

That was 3.64 million barrels a day of refining capacity.

But as we have seen after storms in the past month, once the situation is clarified, then the prices of oil, petrol and gas will ease quite quickly.

And that’s what seems to have happened after Ike as oil fell in early electronic trading in new York to $US99.25 after dropping to $US98.75 a barrel early this morning, our time.

The October New York contract briefly dipped to $US99.99 on Friday, falling under the $US100 level for the first time since April 1.

But Nymex crude in New York rose 31c to close at $US101.18 a barrel.

In London, October Brent North Sea crude eased 6c to settle at $US97.58 a barrel.

Oil prices are down $US47.29 a barrel since the peak of $US147.47 on July 11.

For all the sound and fury of Ike, the real story remains the continuing dip in American consumption of oil-based energy products.

US energy consumption is down 3.8% over the past four weeks compared with the same period in 2007, while petrol consumption is down 2.1%.

 

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On the Chicago grain markets, the emphasis is shifting as the harvest gets underway and the yields of wheat, corn, soybean and other crops becomes clearer.

The United States Department of Agriculture said on Friday that the hugely important corn harvest won’t be as big as thought because of widespread dry, warm weather last month.

The USDA said farmers will harvest 1.8% less corn than forecast last month, while the soybean harvest will be down 1.3%, but wheat output will be higher in both the US and globally.

The USDA forecasts steeper increases in corn and soybean prices, which have eased from the record levels set earlier in the year.

December corn rose 30 USc, or 5.6% on Friday to $US5.6325 a bushel in Chicago. That pushed prices up 2.7% this week. That left the price of the most active contract down 30% from the all time high of $US7.9925 in late June.

November soybean futures rose 26c, or 2.2%, to $US12.02 a bushel in Chicago. The price rose 2.1% last week. Beans are down 27% from the all time high of $US16.3675 hit in early July

The USDA said the average cash corn prices in the crop year that began September1 were $US5.50 a bushel, compared with $US5.40 estimated in August and $US4.20 in the most recent year.

The Department said cash soybean prices will average $US12.35 a bushel this crop year (which started on September 1), up from last month’s estimate of $US2.25 and up from $US10.15 in the previous year.

 

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Wheat was the odd one out with prices falling for a third straight week after the USDA made no change in its estimate of US domestic stocks in the coming year, suggesting that there might be more grain than the market thought.

The USDA said it expects US carryover stocks on May 31 (the end of the wheat crop year) will be around 574 million bushels, while exports will total 1 billion bushels, matching the forecasts made in August by the USDA.

December wheat futures fell 7c to $US7.1925 a bushel on Friday, down 4.3% over the week and 19% this year.

The USDA also increased its estimate of global production to a record 676.3 million tonnes, up from last month’s forecast of 670.8 million tonnes.

Canadian farmers will harvest 25.4 million tonnes, up slightly from the August forecast of 25 million tonnes; European Union output will be 147.2 million tonnes, up from 143.2 million tonnes in the August forecast and these will offset declines in Australia and Argentina: Australia will produce 22 million tonnes, down from the 25 million tonnes in the August forecast and Argentina growers may harvest 12.5 million tonnes, 1 million tonnes down on the August estimate.

According to the USDA’s forecast, the US is expected to be the largest exporter of wheat, followed by Canada, Russia, Australia, Ukraine and Argentina.

 

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Copper had its best week in three, rising sharply on Friday as the US dollar lost ground against the euro.

Comex December copper futures added 7.15 USc, or 2.3%, to $US3.194 a pound. The price was up 3.1% last week

The metal climbed from Wednesday-Friday, as signs of declining mine output increased concerns that supplies may be tight next year. Some analysts, especially at Citigroup, are forecasting demand to run ahead of production next year.

Copper was also supported Friday by a fall in Chinese stocks.

Stocks overseen by the Shanghai Futures Exchange dropped 29% to 13,554 tonnes, the lowest level since 2003.

On the London Metal Exchange, three month copper rose $US192, or 2.8%, to $US7,122 a tonne, or $US3.23 a pound.

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Gold jumped Friday, ending a nine-day losing streak, thanks to the US dollar’s fall against the euro.

The euro rose as much as 1.5% against greenback, but ended off 0.3% for the week.

The Australian dollar finished at $US82.36 in New York, up from $US80.48 in Sydney on Friday afternoon and $US81.64 in Sydney the week before.

It was a rare gain for the currency, the first for a month or more over the week and the strongest daily performance for weeks.

Gold fell 4.8% over the week, despite a $US19 dollar an ounce rise on the day.

Comex December gold rose $US19, or 2.5% to $US764.50 an ounce in New York. The metal had fallen 11% from the end of August to last Thursday

Silver also had a rare rise, finishing up 24c, or 2.3%, to $US10.795 an ounce for the December contract. The metal still dropped 12% last week and is down 28% this year.

Gold is down 26% from the record $US1,033.90 reached in March and is off 8.8% in 2008.

 

 .

So much for “decoupling”…

The theory that emerging markets could decouple from U.S. financial turmoil has officially been culled. The index is now in the middle of its worst draw-down since 2002. A major part of the index including Korea, Russia, Taiwan, China, and Brazil is in a complete freefall.

Emerging markets have not escaped the global financial turmoil paralyzing stock and debt markets over the last 13 months. In 2008, the MSCI Emerging Markets Index has plunged 28%. That’s worse than the 20% decline logged by its sister index for the industrialized economies, the MSCI World Index.

Two key markets in the MSCI Emerging Markets Index have been pummeled over the last 60 days: South Korea and Russia. South Korea has dropped 13%, while Russia is down 10%. These two commodity giants are worth a combined 23% of the index, so they both have added to the sectors’ woes this year.

South Korea has won the booby prize for the worst performing currency in Asia this year. The country is down 19.4% versus the resurgent dollar. Last week the South Korean won sank to its lowest levels against the dollar in four years. The won sank despite government intervention to support the currency. Meanwhile, Korean shares have tanked 26% this year.

In Russia, global investors have dumped stocks in Moscow en masse over the last 30 days following its invasion of Georgia. The Moscow RTS Index, loaded with natural resource stocks, has crashed 36% in 2008. The ruble is also weakening against major currencies, despite Russia’s US$500 billion war chest of foreign-exchange reserves.

Other emerging markets are also declining sharply in 2008. Chinese stocks have crashed almost 60% this year followed by a 44% loss in India. The BRICs, or popular emerging market countries, that include Brazil, Russia, India and China, have collapsed 33% in 2008.

But do the emerging markets deserve this sort of valuation?

Emerging markets continue to sport far superior economic fundamentals than the major markets. Banks in the sector don’t have questionable balance sheets like those in the West. These banks have loads of free cash and will probably continue acquiring distressed American and European financial assets.

For the most part, emerging markets in Asia, including Russia, already went through a major economic crisis 10 years ago.

Boosted greatly by a bull market in raw materials since 2002, these countries are still home to almost US$3 trillion worth of reserves and high savings rates.

If oil and food prices continue to decline this fall, then you can make a strong case for buying this asset class again. Once inflation lowers and interest rates stabilize, we’ll see bullish developments in this region again. But before this can happen, U.S. asset markets must stabilize.

NEW YORK - Stocks steadily climbed back after initially falling in the US overnight, as investors snapped up some of the financial sector’s stronger players and pumped money into the materials and transportation sectors.
Traders dumped Lehman Brothers, but other banks that traded poorly during the day jumped in afternoon trade as punters bet that at least some institutions are in better shape than the troubled merchant bank.
A drop in crude below $US101 a barrel also boosted the market.
The Dow Jones Industrial Average, after dropping 170 points early on, clawed itself back to finish up 164.79 points on the day, or 1.46 per cent to 11,433.71, while the broader Standard & Poor’s 500 lifted 17.01 points, or 1.38 per cent, to 1,249.05.
The NASDAQ rose 29.52 points, or 1.32 per cent, to 2,258.22.

LONDON - European stock markets slumped on Thursday in the wake of heavy falls in Asia, pulled down by sharp losses for banking stocks as the global economic outlook seemingly turned darker.
Fears near to home that the European economy is at risk of recession dampened sentiment, and saw the euro strike a one-year low versus the dollar.
In London, the FTSE 100 index dropped 47.8 points, or 0.89 per cent, to 5,318.4.

FRANKFURT - Germany’s DAX 30 gave up 31.42 points, or 0.51 per cent, to 6,178.9.

PARIS - France’s CAC 40 shed 34.59 points, or 0.81 per cent, to 4,249.07.

TOKYO - Share prices in Japan fell on Thursday after a turnaround plan by Lehman Brothers failed to galvanise markets, sparking fresh worries on the US financial sector.
The Tokyo Stock Exchange’s benchmark Nikkei 225 index dropped 244.13 points, or 1.98 per cent, to close at 12,102.5.

HONG KONG - Hong Kong share prices closed down on Thursday, marking an 18-month low, as investors dumped shares in China firms amid deepening fears of a global economic slowdown.
The benchmark Hang Seng index plunged 611.06 points, or 3.06 per cent, to 19,388.72.

WELLINGTON - New Zealand share prices closed lower on Thursday, dragged down by regional markets after making early gains on the NZ central bank cutting interest rates by 50 basis points.
The benchmark NZX 50 index lost 10.32 points, or 0.31 per cent, to close at 3,333.543.

SYDNEY - Australian markets have received a strong lead from Wall Street equities overnight, which finished almost 1.5 per cent higher. Oil, silver and gold were down, while copper was marginally higher.
At 0757 AEST, the Sydney Futures Exchange’s September Share Price Index contract was 43 points higher, or 0.89 per cent, to 4,878.
In news today, BlueScope Steel chief executive Paul O’Malley addresses the American Chamber of Commerce in Melbourne.
The Warehouse Group releases annual results.
Western Areas NL will hold its annual general meeting.
Style Ltd conducts a general meeting.
In Perth, it’s day three of the three-day Centre for Engineering Leadership and Management conference in Perth.
Yesterday, the benchmark S&P/ASX200 fell 91.2 points, or 1.85 per cent, to 4,814.3, while the broader All Ordinaries shed 89.9 points, or 1.81 per cent, to 4,871.5.

NYMEX

Gasoline prices jumped to unprecedented levels in the wholesale markets on Thursday as Hurricane Ike tore across the Gulf of Mexico, but despite the growing worries, funds continued to liquidate investments in crude, anticipating a slower global economy and stronger US dollar.
Light sweet crude for October delivery fell $US1.71 to settle at $US100.87 a barrel on the New York Mercantile Exchange, after dropping as low as $US100.10 a barrel.
The last time NYMEX crude traded below the $US100 mark was on April 2.
In London, Brent crude on the ICE Futures exchange fell $US1.33 to $US97.64 a barrel.
The wholesale price of gasoline ranged from $US4 to nearly $US5 a gallon on the US Gulf Coast on Thursday. That is up significantly from about $US3 to $US3.30 a gallon on Wednesday.
The market’s renewed storm worries arrived a day after the US Energy Department reported a larger than expected drop in crude and gasoline inventories, and OPEC decided to cut excess production by about half a million barrels a day.
A decision by OPEC on Wednesday to reduce output by 520,000 barrels a day failed to boost oil prices, which have fallen by 30 per cent since reaching a record $US147.27 on July 11.
In other NYMEX trading, heating oil futures rose 1.31 cents to settle at $US2.9155 a gallon.
Natural gas fell 14.5 cents to settle at $US7.248 per 1,000 cubic feet. The EIA said Thursday that natural gas in US storage rose last week.
CME Group, parent of the New York Mercantile Exchange, will open energy trading on the CME Globex and ClearPort platforms earlier than usual Sunday due to the hurricane.

COMEX

Gold fell again overnight, sliding below $US750 an ounce, continuing its longest decline for eight years.
Silver followed suit, to its lowest since June 2006, as precious and other metals continue to lose their lustre as safe havens and inflation hedges.
Gold is now down 28 per cent since March, partly attributable to the $US rising 15 per cent against the euro. The greenback hit an all-time low against the euro in July.
The US currency has hit its strongest level for a year, while concurrently the Reuters/Jefferies CRB Index, which houses 19 commodities, fell to its lowest level since late January.
Gold futures for December delivery fell $US17.00, or 2.2 per cent to $US745.50 an ounce on COMEX.
That was the ninth straight loss, a run not seen since September 2000.
Silver futures for December delivery fell 33.5 cents, or 3.1 per cent to $US10.555 an ounce.
The havoc is being caused by the global slowdown, with countries not needing metals of any description if economies are going into recession.
Meanwhile, a recovering US currency is a better bet than hiding money away in physical gold, particularly as everyone else seems to be selling the soft metal.
Gold hit a record of $US1,033.90 on March 17.
Wheat futures for December delivery rose 0.5 of a cent to $US7.2625 a bushel on the Chicago Board of Trade, mainly on US exports to countries including Japan.
Wheat has dropped 46 per cent from a record $US13.495 on February 27.
Corn fell on the CBOT for the third session straight as world demand for ethanol feed, together with some countries’ possible inability to pay for food, hit both that crop and soybeans.
Corn futures for December delivery fell 3.5 cents, or 0.7 per cent to $US5.3325 a bushel.

Commodities, especially oil and gold, are in a correction. But make no mistake: We’re NOT at the cusp of a bear market. On the contrary, smart investors should take advantage of currently depressed prices to aggressively accumulate shares in select precious metals and energy companies.

Since hitting an all-time high on July 3, 2008, the benchmark Reuters-CRB Index has declined 20% while crude oil prices have tanked 25%. Other commodities have declined even more. And gold stocks, as measured by the XAU Gold & Silver Index are down a blistering 35% since June.

Admittedly, the recent peak in oil prices was extreme, if not symptomatic of a short-term “bubble.” The same was true for most commodities where institutional fund-flows were manic in the hunt for positive returns the first six months of 2008.

Commodities have been the prime recipients of a global institutional boom. We’ve seen more commodity exchange traded funds this year. Also, hedge funds have been pouring money into commodities as managers searched for one of the few remaining profitable market segments in an otherwise horrible year for equities and bonds.

So Much for the “Big Trade”

The “big trade” over the last 12 months for hedge funds has been riding the wave in commodities, including oil and shorting or betting against financial stocks. And that trade reversed violently in July.

But while the market is right to discount a slowing global economy, it’s wrong to assume that the bull market in oil and most other commodities is over. You simply can’t make a case for the death of the bull when short-term cash rates are still below the rate of inflation and global money-supply (M-2) is growing in excess of almost 20% year-over-year, according to Grant’s Interest Rate Observer.

It seems as though investors who don’t remember the lessons of history are doomed to commit the mistakes of the past.

Remembering the 1970s Correction

Commodities are extremely volatile. Knowing that, it’s flat-out ridiculous to call this decline “a bear market” just because prices are down 20%. Oil, gold and other commodities plunged by almost 50% in the mid-1970s during the bull market. Then commodities went utterly gangbusters by 1980. Commodities can decline sharply even in a secular bull market.

But what about the U.S. dollar and its impressive 360-degree turn since mid-July against all major currencies? Isn’t that a bad omen for commodities? No. Longer term, the dollar is relegated to the dustbin as a laundry list of deficits hamper any serious gains or bear market rallies.

What’s amazing here is that everyone is running to buy dollars when the United States is still accumulating out-of-control deficits.

The Treasury’s budget deficit in July nearly tripled to US$102.77 billion, up 182% from July 2007. But what difference does it make? The U.S. just spends like crazy and the rest of the world finances this ponzi-scheme. It might not be this year or next year. But at some point, there will be a global crisis in confidence as America’s debt-to-GDP ratio, already at 6%, just explodes to uncontrollable levels.

But it’s not just budget deficits that threaten the dollar. There are also trade deficits as far as the eye can see. We’re also seeing two seemingly endless and expensive military conflicts. We have bulging social entitlement spending programs that have yet to peak. Not to mention, we have to finance more expensive financial institution bail-outs including the costly nationalization of Fannie Mae and Freddie Mac. The list goes on and on…

How can a sensible investor not own gold and other tangibles in this madness?

In order for the United States to support all of this profligate spending it must expand credit or print money. And printing this sort of money – a colossal amount – will ultimately result in much higher inflation in 24-36 months.

Central Banks Are Determined to Stoke Inflation and That Will Benefit Commodities

Any way you slice it, this has been a bruising correction for commodities. But don’t call it a bear market. Commodities, unlike stocks, are far more volatile and can record daily price swings that are extremely wild – exceeding 5% or even 10% in a single day.

But bull markets in commodities don’t end with negative inflation-adjusted interest rates or with global money-supply (M-2) expanding at more than 20%. In the 18 years I’ve been in this business I’ve never seen credit expand at this rate – never. This tells me world governments are growing desperate to grow inflation amid a deflation in credit expansion and real estate. It’s inflate or die for the world’s central banks.

The next few months might continue to be painful for commodities. We are probably more than 50% of the way through this correction now with many commodities still in net supply deficit.

The way I see it, investors are confused because they can’t identify the current stage of the economic cycle. Are we still in an inflationary surge or is this the beginning of global deflation?

It’s this seemingly new direction in asset prices since mid-July that has triggered a wholesale run on commodities and an up-crash for the dollar. It’s been lightning fast and many investors are getting mauled.

It looks like the world economy is starting to deflate after a big post-2002 expansion. The forces of inflation and deflation are now fighting each other for the first time since 2001 and ultimately, inflation will win. If it doesn’t then the banks, financial markets, housing and everything else that revolves around finance and credit goes into the gutter.

Well here’s the good news. The Australian economy has gone for 17 years without a recession. That’s a pretty impressive growth spurt. But if the economy were a teenager, you’d wonder how much growth was left.

–The economy is not a teenager, of course. Australia’s $1 trillion economy is much more complicated than the mind of a 17-year old, probably. But for the record, growth in the second quarter was just 0.3%. Year over year, Aussie GDP grew by 2.7%, which is better than the U.S. (2.2%), the U.K. (1.4%), and Germany (1.7%).

–Former U.S. Senator Everett Dirksen allegedly once said that the main purpose of GDP is to make everything else look small by comparison. And really, who goes around and ads up the value of all the transactions in the economy in any given quarter? Aren’t these numbers a bit of a fraud? And isn’t the obsession with them based on another fraud, that the economy is finely tuned machine that can be tweaked, prodded, and manipulated by policy makers?

–In any event, the share market was not sufficiently cheered by Australia’s relative out-performance in GDP terms. Shares got shellacked. Even the decision by the Reserve Bank to cut the cash rate to 7% was not enough to kick start the market higher. And the decision actually kicked the Aussie dollar down its lowest levels in a year.

–So has anything really changed this week? It sure doesn’t look like it. Buried in the GDP data is the fact that Aussie household spending fell. What did you expect? We are starting to find out how much consumption in the economy was financed with credit cards or borrowing on other assets like cares or shares.

–In terms of personal virtue, more saving and less spending is probably good for a man. In the aggregate, it leads to lower GDP growth. But if the growth comes at the price of debt, well, perhaps we should try doing without for a few quarters. You’d get a different kind of economy over time, but it might be more productive and less indebted.

–Here in America, it’s all politics all the time. It’s enough to make a man sick to his stomach, which is how your editor has been for the last few days. It could be the jet lag. But we reckon it’s the spectacle of tens of millions of people who sincerely believe that it’s possible to live at one another’s expense. Yeesh.

–In the markets, all the action is in the currencies, which is in turn setting of reactions in oil, gold, and commodities. The U.S. dollar has started to look like the least ugly currency on the market lately. The British pound is reeling under the staggering incompetence of Gordon Brown and Alistair Darling (and Britain’s housing and debt bubbles.).

–You know what we think of the greenback over the long haul. But the dollar rally may have some legs, especially if you keep seeing increased political risks in Asian markets (Japan, Thailand, Indonesia). We had lunch with an old colleague yesterday who said it looked like shades of 1998 and the currency crisis, but with a few variations.

–What variations? Well, in 1998, the U.S. was coming off a rare (and truth be told fictitious annual budget surplus). Tax profits were pouring into Federal coffers faster than the Federal government could dole it back out. The dot.com boom was entering its irrational phase, and the dollar looked like a King.

–Today, U.S. Federal finances are not nearly so rosy. The government is going to run an annual deficit of nearly half a trillion dollars. But still, in the game of global fiat currency competitive devaluation, other countries are following what the Fed began last year.

–The stronger dollar will put a lid on oil and gold, and probably deal a few more kicks to the mining companies, and the morale of resource investors. We wouldn’t be foolhardy and average down. But you should still keep a careful list of good resource projects with excellent mineral deposits. And then try to buy them on sale.

Readers, driving to work this morning in our Sportswagon – and we don’t mean the fancy new Holden version either, we’re talking the vintage 1996 Hyundai Lantra edition – we realized who the tough guys are in the markets.

These are the real tough guys. Not the sort that talk big but then have to get a hitman to ‘take you out,’ these will do it all for themselves. These are the people who when you hear them being interviewed on CNBC don’t talk with a normal voice; a voice that sounds as if they’ve had their voice box ripped out and replaced with a supercharged V12 engine.

I’m talking about crude oil traders.

What makes them take out the award for toughness? Well, let’s take a look at the oil price over the last couple of months. As recent as early July the price of crude oil had raced ahead to nearly USD$150. At that stage the talk was all about the price reaching USD$200. The oil analyst at US investment bank GoldmanSachs even put out a research report saying so.

And it still may do that, but since then the price of crude oil has only really gone in one direction – down. In fact it is down by approximately 25%, trading overnight to as low as USD$110 a barrel.

Anyone would think that the world has fallen asleep since the start of July, but of course it hasn’t. We’ve had supply disruptions in Nigeria; we’ve had war – albeit a little one – between Russia and Georgia; we’ve had threats from Russia to reignite the Cold War; we’ve had hurricanes in the Gulf of Mexico; nationalizations in Central and South America.

Yet despite all that, the oil traders have sat back and said “so what,” “seen that before,” “what else have you got?” I even dare say that they’ve shouted “BORING!” at their computer screens.

What does that mean for you? Well, one thing it definitely does not mean is that the price of crude will never go back up again. Because it could. And it will if supply continues to be constrained, and if demand continues to rise.

Risk is Being Priced Out of Oil
What it does mean is that traders have now removed some of the risk premium from oil. Terrorist strikes in Iraq were removed long ago, no-one cares anymore. But a major hurricane in the Gulf of Mexico hadn’t been taken out until now. A potential military conflict in the Caucasus wasn’t even seen as a risk until it happened, and was then just as quickly removed as a concern.

Even so, with all these factors having been stripped away from the price of crude oil it still remains more than four times higher than it was in 2002.

This leaves us with the major factor that the oil market really cares about, and the one that will take you all back to your high school or university economics classes – Supply & Demand.

Crude oil is now priced at around USD$110 a barrel based almost exclusively on whether there is enough supply in order to meet demand. If the price falls a bit then it is because the market believes there is enough. If it rises a bit then it is because the market believes there isn’t enough.

But a look at the statistics from the International Energy Agency (IEA) tells us that there isn’t exactly a big buffer between the amount supplied and the amount demanded.

As this chart shows us, in 2007, total world supply of oil and oil-like products was 85.6 million barrels per day…

 

Yet also in 2007, the demand for oil and oil-like products was… 86.1 million barrels of oil per day. In other words the world wanted 500,000 barrels of oil more per day than it was able to produce during the year.

Tough Guys Keeping Down the Price of Petrol

Readers, driving to work this morning in our Sportswagon – and we don’t mean the fancy new Holden version either, we’re talking the vintage 1996 Hyundai Lantra edition – we realized who the tough guys are in the markets.

These are the real tough guys. Not the sort that talk big but then have to get a hitman to ‘take you out,’ these will do it all for themselves. These are the people who when you hear them being interviewed on CNBC don’t talk with a normal voice; a voice that sounds as if they’ve had their voice box ripped out and replaced with a supercharged V12 engine.

I’m talking about crude oil traders.

What makes them take out the award for toughness? Well, let’s take a look at the oil price over the last couple of months. As recent as early July the price of crude oil had raced ahead to nearly USD$150. At that stage the talk was all about the price reaching USD$200. The oil analyst at US investment bank GoldmanSachs even put out a research report saying so.

And it still may do that, but since then the price of crude oil has only really gone in one direction – down. In fact it is down by approximately 25%, trading overnight to as low as USD$110 a barrel.

Anyone would think that the world has fallen asleep since the start of July, but of course it hasn’t. We’ve had supply disruptions in Nigeria; we’ve had war – albeit a little one – between Russia and Georgia; we’ve had threats from Russia to reignite the Cold War; we’ve had hurricanes in the Gulf of Mexico; nationalizations in Central and South America.

Yet despite all that, the oil traders have sat back and said “so what,” “seen that before,” “what else have you got?” I even dare say that they’ve shouted “BORING!” at their computer screens.

What does that mean for you? Well, one thing it definitely does not mean is that the price of crude will never go back up again. Because it could. And it will if supply continues to be constrained, and if demand continues to rise.

Risk is Being Priced Out of Oil

What it does mean is that traders have now removed some of the risk premium from oil. Terrorist strikes in Iraq were removed long ago, no-one cares anymore. But a major hurricane in the Gulf of Mexico hadn’t been taken out until now. A potential military conflict in the Caucasus wasn’t even seen as a risk until it happened, and was then just as quickly removed as a concern.

Even so, with all these factors having been stripped away from the price of crude oil it still remains more than four times higher than it was in 2002.

This leaves us with the major factor that the oil market really cares about, and the one that will take you all back to your high school or university economics classes – Supply & Demand.

Crude oil is now priced at around USD$110 a barrel based almost exclusively on whether there is enough supply in order to meet demand. If the price falls a bit then it is because the market believes there is enough. If it rises a bit then it is because the market believes there isn’t enough.

Who’s Afraid of the Dark?

And as we can see in this chart, demand forecasts by the IEA are set to continue to increase over the next two years. The IEA does not have a forecast for supply over the same period, which unfortunately leaves us all rather in the dark.

Perhaps that is why oil traders are the tough guys in the markets. They aren’t afraid of the dark.

Let’s talk about oil and gas. Right now, you’ll be hard pressed to find a bigger influence on the stock market’s movements than energy prices.

The banks and financial stocks had their 15 minutes of fame during the worst of the credit crisis…but now it’s the energy sectors turn to rule the fickle whim of the market.

Of course, oil prices control more than just stocks. I don’t have to tell you what US$150 does to the overall economy and more specifically to your own personal wallet. I know I changed my spending habits since gas climbed above US$4.10 a gallon.

Earlier this summer, we all watched as oil steadily climbed to the once unthinkable level of US$147 per barrel. As a result, it seemed the entire country went “green” overnight. You started hearing phrases like “let’s conserve,” and “we need to find alternative sources of energy.”

But look how easily we slipped right back into our old habits as soon as oil prices slipped below the “manageable” level of US$115.

Old Oil Habits Die Hard

A few weeks ago, everyone was chattering nonstop about gas prices. Everyone was moaning about how much more each trip to the grocery store cost.

You heard friends talking about what kind of bicycle they were going to buy if gas climbed much higher. You even heard the talking heads chattering about how wind, water and nuclear power would save us from these sky-high gas prices.

Then, magically we wake up one day, and gas is down to a “reasonable” US$3.70 a gallon. Life is good again…for now.

But what happens when oil rises again? It’s worth considering because right now tropical storms (aka hurricanes in training) Gustav and Hanna are swirling around the U.S.’s main source of oil.

If they should hit us where it hurts the most - in the country’s oil reserves in the Gulf - then we’ll be right back where we were earlier this summer.

My Own Personal Connection to Our Oil Reserves

I spent almost eight years working as a geologist offshore in the Gulf of Mexico. Among other tasks, my job was drilling wildcat, exploratory oil and gas wells. So I know what it’s like to be on a drillship, hundreds of miles from the nearest piece of dry land when a hurricane is heading straight for you.

As an experienced oil driller, I can tell you there are hundreds of drilling rigs and production platforms sitting in the Gulf.

Every single one of them has to be “prepared” for the worst in case a hurricane hits. When a storm is coming, all drilling stops, wells are shut in, and all personnel are transported by boat and helicopter to shore.

With Gustav’s current projected track, I’m sure this process has already begun. Wells have stopped pumping, workers are headed home and everyone is sitting tight, with their fingers crossed and hoping for the best.

All the refineries along the Gulf Coast are also going through their emergency preparation shut-down plans. The refineries themselves are huge, complicated and potentially dangerous industrial complexes. That means they can take a long time to power down. Right now, I’m sure their fingers are on the “off” switch in preparation for what could be devastating storms.

This means, the refineries have lost one week in preparation for the storms, and another week in getting back online.

The Hits Just Keep On Coming…this Time with Hanna

And just as Gustav blows through - Hanna is sitting on its heels. Currently, Hanna looks like it may turn a little more North and run up the east coast of Florida, but there’s really no way to be sure this early.

Now if you’re in charge of the oil and gas wells, refineries and personnel for the Gulf, then you’re faced with a difficult decision. You have already stopped all drilling, pulled the drill pipe out of the hole, secured the rig and shut down in all production. The refineries are on emergency hurricane shut-in and the workers have gone home to be with their families.

So do you call everyone back as soon as Gustav passes and hope Hanna is a no-show? Or do you just plan to wait it out another week? From my experience - they’ll wait it out. It’s just too expensive and much too dangerous to risk it.

Could Russia Knock Us Out for the Count?

And then there’s Russia - and this could turn out to be the knock-out punch.

You see, as Russia occupies Georgia, the Russian oil supply becomes a real concern for all of us. The pipeline that crosses Georgia can pump slightly more than one million barrels of crude oil per day, or more than 1% of the world’s daily crude output. That 1% may not sound that bad, but in a world where we actually use more oil than we produce every single day, 1% can make a huge difference.

The 1,100-mile pipeline carries oil from Azerbaijan’s Caspian Sea fields. It’s estimated to hold the world’s third-largest reserves. This pipeline is already vulnerable. We saw that last week when it was sabotaged, apparently by Kurdish separatists.

Most of the oil is bound for Western Europe and with only so much oil to go around, what the pipeline carries affects prices everywhere.

So, what are we to do?

Well if you’re trading oil or natural gas short-term, you may just get a quick spike up in price. Take this as a gift as I believe the longer term trend for oil over the next few months is down and will settle in to US$100 per barrel +/- $10.

This won’t last forever. The hurricanes will pass. Russia and Georgia will eventually sort out their differences.

But in the meantime, look for oil to spike once again. It’s a virtual certainty with hurricanes waiting to pummel the Gulf.

 

But its not all doom and gloom on the markets, some companies are actually making money. Such as oil junior AED Oil [ASX:AED] released its first annual report showing revenues today.

Revenues of $144 million, and a net profit (including asset sales) of $242 million. The company has got a bundle of cash, $348 million and only a marginal amount of debt after selling a 60% stake in its assets to Chinese oil company Sinopec.

The company managed to secure an average oil price of USD$109 a barrel for the 1.379 million barrels that it extracted last year.

The share price remains a long way below the peak it reached last year of $11.40.

NEW YORK - Wall Street ended mixed on Tuesday as concerns about the path of Hurricane Gustav sent oil prices higher and offset a better-than-expected reading on consumer confidence.
Comments from the Federal Reserve about rising inflation added to the market’s unease.
The Dow Jones Industrial Average managed a gain of 26.62 points, or 0.23 per cent, to 11,412.87.
The technology-heavy Nasdaq fell 3.62 points, or 0.15 per cent, to 2,361.97 while the broad-market Standard & Poor’s 500 index added 4.67 points, or 0.37 per cent, to 1,271.51.

LONDON - European stock markets closed mostly firmer on Tuesday, recovering from early losses as investors cheered better-than-expected but still weak US consumer confidence figures.
London bucked the firmer trend, with the FTSE 100 index fell 34.90 points, or 0.63 per cent, to 5,470.70 points.

FRANKFURT - The DAX was up 43.57 points, or 0.69 per cent, to 6,340.52.

PARIS - The CAC 40 index added 12.68 points, or 0.29 per cent, to 4,368.55.

TOKYO - The benchmark Nikkei-225 index lost 99.95 points , or 0.78 per cent, to 12,778.71.

HONG KONG - The benchmark Hang Seng Index fell 48.13 points, or 0.23 per cent, to 21,056.66.

WELLINGTON - The sharemarket improved during the day after an early slide, but failed to make it into the black despite some solid company results.
The benchmark NZSX-50 index closed down 5.91 points at 3,321.0.

SYDNEY - The Australian stock market is expected to open in positive territory after US stocks ended mostly higher overnight.
At 0740 AEST on the Sydney Futures Exchange, the September share price index futures contract was up six points at 4,992.
Today, the Australian Bureau of Statistics (ABS) releases preliminary data on construction work done in June.
Companies releasing annual results include IOOF Holdings, Westfield Group, Transurban Group, PrimeAg Australia, Hastie group, Regional Express Holdings, Macquarie Media Group, GPT Group, Gloucester Coal, Australian Vintage and Australian Infrastructure Fund.
Woodside Petroleum’s interim results are due.
The Australian share market closed marginally lower yesterday, with mixed performances from many sectors after a weak US lead overnight provided little direction.
The benchmark S&P/ASX200 index was down 7.4 points, or 0.15 per cent, to 5,007.5, while the broader All Ordinaries shed 7.8 points, or 0.15 per cent, to 5,082.3.

NYMEX

Oil prices rebounded on Tuesday on concerns that a strengthened Hurricane Gustav could damage energy facilities in the Gulf of Mexico.
New York’s main contract, light sweet crude for delivery in October, climbed $US1.16 to close at $US116.27 a barrel.
In London, Brent North Sea crude for October added 60 US cents to settle at $US114.63.
Oil bounced higher as Gustav grew from a tropical storm into a hurricane Tuesday.
The storm barreled into Haiti, packing powerful winds and heavy rains that were likely to cause massive destruction throughout the desperately poor Caribbean nation.
Gustav was also on a path to strike Jamaica and Cuba, and possibly offshore oil rigs in the Gulf of Mexico later in the week - a threat that led to a spike in oil futures prices.
Anglo-Dutch energy giant Royal Dutch Shell meanwhile said it was planning to evacuate some staff from its Gulf facilities because of Gustav.
Earlier on Tuesday, oil prices had fallen as weak German data stoked concerns about slowing global economic growth and lower demand for energy.
Heightened tensions between Russia and Western countries over Moscow’s military action in Georgia also stoked supply concerns.
Investors were worrying that a new standoff could interrupt the pipeline flow of Azerbaijani crude from the Caspian Sea to the Turkish port of Ceyhan on the Mediterranean.
Oil prices have tumbled from record highs above $US147 set on July 11 after breaking through $US100 at the start of the year.

COMEX
Gold futures for December delivery added $US2.40 to $US828.10 an ounce on the Comex division of the New York Mercantile Exchange.
Silver for September delivery increased 0.205 US cents to settle at $US13.575 on the Nymex while September copper fell 0.0430 US cents to settle at $US3.4385 a pound.