Why Oil Has Dropped, and Where It's Going
The mainstream media, and even most non mainstream places, are completely clueless as to the cause of the drop in oil and other commodities. I began to realize what was going on late last week.
It's the olympics.
Now you must be thinking, what drugs has The Demon taken, and where can I get some, to think that the olympics by themselves have caused oil to go down.
Well now folks, I can assure you other than some Robert Mondavi (RIP) Pinot Noir, I'm as sober as a librarian.
Here's the why's and hows of the situation:
China is the most air-polluted country on the planet. This is what happens when a country goes through rapid industrialization with zero environmental restrictions. (Remember, this is a country with no eminent domain - they've literally taken and plowed under entire cities for infrastructure projects. As inhumane as that may sound, it has led to a far greater efficiency in ramping up industrialization). With the olympics rolling around, China started to pull out all the stops to try to improve their air quality. Entire factories and energy plants shut down. Cars driving only on odd or even days based on license plates. What is not known, however, is the overall demand destruction, and how much of the China machine has been shut down.
I am theorizing that it is almost all of it. "China's crude imports unexpectedly fell 7 percent in July to a seven-month low in the steepest monthly drop since January 2005, as refiners balked at soaring crude costs amid lagging domestic fuel prices."
""I think that sentiment is changing on China -- that it (demand) might not grow at the same rate that it has in the past couple of years -- and the figures from this morning attest to that," said Lehman Brothers oil analyst James Crandell."
Right data, wrong conclusion.
Crude prices were basically even in June and July. Don't believe me? See the numbers for yourself: http://tonto.eia.doe.gov/dnav/pet/hist/rwtcd.htm
The right conclusion is the China industrial machine slowed down for July. It is likely also shut off right now during the games, and I would not be surprised to see crude imports flat or even a bit lower for august than july (and prices for august will be definitely lower). The estimate was that China, for 2008, is building 100 miles of road per day in the country; my guess is the total for this week and next week will be zero miles.
If anyone is in China or knows someone there and can give a "boots on the ground" view, it would go a long way to confirming or refuting my assertation.
But if my assertations are correct, here is what will happen:
Every bottom caller in financials and dollar based stocks is going to look like an idiot (if they already don't).
Oil will continue to fall, ending lower at the end of this week than it was at the beginning. Next week (8-18 to 8-22), oil may still be falling overall, but by the end of the week, China will be starting to roll in it's oil orders again to flip the industrialization switch to the "on" position. By 8-22 you will see oil rising, and by the last week of august you will definitely see an upswing in oil prices.
Inflation fears will be talked about, McCain will be blabbering is head off about off-shore drilling which won't do anything but make the US more dependent on oil, Obama will maintain his energy plans, certain bloggers will talk about how both are complete idiots and how they wish Ron Paul were a viable presidential candidate, airlines will go down while oil and energy stocks (including solar) will continue on their ascent. Oh yes and Paulson will continue to talk about the "strong dollar" as it continues it's slide inot the abyss.
And oh, I've only been talking about oil, but the China forced-slowdown has hit all commodities hard. Watch for all base metals especially to end this week lower, and start rising by the end of next week. Now is a good time to look into a position of a stock like PCU, AUY, BHP, RIO, and on the energy side I still like SU (a buy below 45 if it gets there), HP, HLX, and RIG, and now also might be the time to go in on a royalty trust like PWE.
By the end of August you will see talks of the dollar's strength fading, more recession/fear talks, we won't have capitulation yet, I expect that around October which is the month that the bad stock days really happen. Until we get a 10% down day where the trading curbs kick in, we still have not seen real capitulation.
Semi off-topic for this subject, I really enjoy reading Mish's blog, I know a lot of you guys out there follow him. I love how he breaks down companies and industries, however his tired arguments about deflation don't pass the smell test, at least for those of us that understand the difference between the FIRE, Government, and Real economies. He asserted that there will easily be 2T in losses in 2 years and the Fed and US Gov't can't print that much in 2 years. I beg to differ, in 7 months this year we've already gone to 768B of new money out of thin air which would, annualized, be far over 2T in losses. (Ag bill = 300B, Bailout bill = 300B, and that's a minimum that allows the treasury to print more bail out FNM/FRE, and stimulus = 168B, for a grand total of 768B). That's almost 800B out of thin air people, and that's inflationary, annualized 1.3T a year. How does 30% inflation a year strike you? And this sort of relates to the topic at hand, because Mish is now pounding the table talking about how right he was, because we now have "deflation" in oil and gas prices. This hubris will be short-lived as oil and energy continues to be come more expensive as money becomes more diluted and worthless.
So, in conclusion, China has shut down temporarily for the olympics which has created a large decrease in global oil and commodity demand. As they ramp up operations near the end to after the olympics, that demand will come back as oil marches it's way to 200/bbl by 2010.