- New Science in old markets -

China and that feedback effect in crude. Energy is compressed

We pointed out in the May 16th edition that a Chinese stock index that we follow had compressed and that you should buy it if it were to break upward. It did, so you should now be long. An update:

The broad market index also compressed and broke upward and has made a more impressive move. There will probably be more to come but we should note that these were only compressions at a daily scale and so we can only rely on them for three weeks or so. This doesn’t mean ‘Sell China’ but it does mean that we will keep looking for fresh signals to advise whether you should stay long for the longer-term. So far, so good.

In US and European equity markets we remain bearish and recently advised buying bonds too – these assets still move in opposite directions much of the time and so these two recommendations overlap a lot. There is a turn coming up on the 4th that seems likely to provide a low point on which we may recommend covering equity shorts. Our bearish view of equities in these two regions remains undimmed but prices will fluctuate and we hope to try to catch some of the 2-way movement.

Elsewhere, energy markets are compressed at a weekly scale. This is interesting as we are generally bearish about commodities and have been looking for a chance to sell these and other ‘industrial’ commodities short. This could be it, so watch for a break and be prepared to follow it, if that break is downwards.

If instead there is an upward break, we would only buy for a ‘trade’ and not for the longer term. There is a profoundly bearish argument about crude oil prices that we made at the end of the January 8th edition. Here it is again:

Saudi Arabia’s changed financial position may have an effect on oil production. This large producer is no longer a ‘low absorber’ of the oil income that it generates and its increasingly lavish expenditure means that it now needs that revenue. If and when oil prices next fall for more than a few weeks, Saudi Arabia will need to keep pumping instead of reducing production to nudge the price back up as it has done many times before. The negative, price-limiting feedback produced by Saudi Arabia acting as ‘swing producer’ will be replaced by the positive feedback effect of continued selling into a weak market. Other OPEC members will naturally follow suit and the consequences will be a very low oil price, for a while at least.

Establishing strategic short positions in energy markets may be risky but the global game has changed lately - not just because of the increased supply of natural gas from ‘fracking’ in the US, but because of these financial dynamics within OPEC member states too. Saudi Arabia has held the price down for years because of the fear that cutting production to force prices up (as wanted by some other OPEC members) would encourage new supplies of energy. That has now happened at the same time that the financial needs of Arab countries are increasing and their financial reserves have been stolen diminished. Sooner or later, prices will fall and this could be the moment for that drop to start. There may be better ways to position for a drop than by selling crude futures but we leave that to others to decide – perhaps ‘big-oil’ company shares are the better short-side play?