Tag Archives: economics

Major Bond Warning

moneyMy Comments: A recent letter to the editor of the Gainesville Sun suggested there was a conspiracy afoot, run by the US Government, to whit “How was it possible for anyone to survive when banks were only paying 1% on Certificates of Deposit.” While the question itself is legitimate, the context implies a vast ignorance of how money works.

I’ve talked in this blog about how interest rates are due to start rising. I’ve talked about how the economy is doing well these days. I’ve talked about the need to position your money so it will have a chance to grow instead of shrink the next time we have a crash.

The following came from a newsletter to which I subscribe. It might or might not help if you have little knowledge about how money works. Here’s what the author said:

In May 2013, I (Porter) gave my first warning.

I told subscribers this was “the single greatest threat to your wealth you will ever face.” Longtime readers might recall I was warning about the bond markets. In particular, I was pointing to the part of the market that provides financing to smaller, faster-growing firms – bonds known as “high yield,” or “junk.”

I know most of my subscribers don’t buy bonds. Most don’t really understand how bonds work – at least, not in any real detail. And when most readers think about interest rates, they probably focus on mortgage interest rates or municipal-bond interest rates.

Here’s the thing, though: If you want to see the next bear market in stocks coming ahead of time, you ought to focus on the corporate-bond market. The corporate-bond market shows how much most companies pay for the capital needed to grow. For some industries, access to such financing is vital. Without a healthy corporate-bond market, some companies would drop to zero almost overnight. And that makes the cost of capital a crucial variable…

Another thing that most investors don’t understand about the bond markets: Interest rates (set by the bond markets) influence how stocks are priced relative to their earnings, their “valuations.” Starting in 2009, the Federal Reserve intervened in the bond markets, driving interest rates lower. That has pushed stock valuations higher, and it has been a powerful driver of this bull market. Higher interest rates, on the other hand, will drive valuations lower. I believe that’s likely to cause our next bear market.

Here’s what I wrote back in May 2013…

The U.S. bond market – particularly the junk-bond market – is going to crash. When this crash occurs, it will be the largest destruction of wealth in history. There has never been a bigger bubble in U.S. bonds. How do I know? It’s simple. Junk bonds (aka high-yield bonds issued by less creditworthy companies) have never yielded less than 5% annually. But they do today. Likewise, the difference between the yields on junk bonds and the yields on investment-grade bonds has almost never been smaller. That means credit is more available today than almost ever before for small, less-than-investment-grade firms. The last time credit was this widely available – and at such low costs – was in 2007. And you know how that turned out…

The coming collapse in the bond market will be far worse than it was last time, too. This time, the Federal Reserve’s actions have driven forward the huge bull market in bonds. The Fed is printing up almost $100 billion per month and buying bonds. That has forced the other buyers of bonds to buy riskier debt that, historically, offered much higher yields.

Today, those yields have been incredibly “compressed.” You can imagine the high-yield segment of the bond market to be like a spring whose coils have been driven together by the force of the Federal Reserve’s market manipulation. As soon as the Fed’s buying stops (and it must stop one day, or else it will trigger hyperinflation), the yields on those riskier bonds will soar again. As bond yields rise, the prices of bonds will fall sharply.

One of the best ways to follow the corporate high-yield bond market is to watch the leading exchange-traded funds that buy huge amounts of corporate bonds, like the iShares iBoxx High Yield Corporate Bond Fund (HYG).

Here’s how HYG has performed since my warning in early May 2013…
15-08 HiYldBonds

As you can see, shortly after my warning, these bonds fell sharply. The funds’ shares dropped from $95 to $89 in a matter of days. They rallied back, though, and roughly a year later (June 2014), they nearly hit a new high. We repeated our warnings in several Digests in 2014 (on May 29, June 4, and June 12).

Here’s what we wrote in the May 29, 2014 Digest…

There’s probably no larger sign of the top than what’s currently happening in the high-yield (aka “junk”) bond market… Investors are lending money to the riskiest corporate credits for near-record-low interest rates – currently a little more than 5%. And these companies literally cannot meet the demand for their paper. According to the Wall Street Journal, of the 10 largest U.S. bond funds at the end of 2013, the four with the fastest growth in assets since 2008 held an average 20% of their portfolios in junk bonds.

That outlook led us to close our high-yield bond newsletter, True Income. There was nothing we wanted to recommend in the entire market.

Still, as interest rates raced for record lows and bond prices shot to record highs, investors decided they had to own junk bonds. While we were shuttering our high-yield bond research, the individual investor began buying junk bonds like never before… many for the first time ever. As former Digest editor Sean Goldsmith wisely noted, “Nobody ever heralded the individual investor for his timing.”

Today, high-yield bonds are trading near their lows of the last three years. HYG is trading around $88 a share. I still believe all the things I’ve written over the last two years: A collapse in the high-yield market will kill the current bull market and wipe out billions of dollars of investors’ savings.

It’s interesting to note that the rising defaults and distress in the bond market are causing the decline in bond prices today, not inflation. In particular, the two fastest-growing parts of the high-yield market for the last decade have been bonds tied to oil and gas companies (some of which have already filed for bankruptcy, many of which are now distressed) and bonds tied to subprime auto lending (which now makes up roughly 25% of all car loans).

I don’t need to tell you that oil and gas prices are way down. As a result, a lot of the investments made into the oil patch over the last decade aren’t going to produce anything like what was expected. As oil and gas companies’ “hedges” expire this year, revenues at most of America’s oil and gas companies are going to go way, way down. A lot of bonds will end up in default.

Likewise, the default rates on newly issued subprime auto loans have been setting new highs, rates much like those in 2008. Specifically, 8.4% of the subprime borrowers who bought a car in first-quarter 2014 missed at least one payment before the end of the year. The early default rate on subprime car loans last peaked in 2008 at 9%. Given that the job market remains strong, this suggest a huge problem in subprime auto underwriting and larger-than-expected losses in securitized auto loan bonds.

Now… consider this. Outside of student loans, auto lending is the only form of consumer lending to grow in the U.S. since 2009. And something like 30% of all the jobs that have been created in the U.S. since 2010 are tied directly to the oil and gas industry. Take the credit weakness in these industries as a significant warning sign. Perhaps all the cars they sold in 2014 (a record for U.S. car sales) can’t actually be paid for… And perhaps all of those oil wells they drilled can’t, either. If that’s the case… no matter how many bonds the Fed buys, defaults are likely going to rise… and bonds are going to fall.

What should you do about this? First and foremost, check your accounts and make sure you don’t own any high-yield bonds. As for other strategies… be aware that a bear market this fall is, in my opinion, likely. Watch your trailing stops. Consider shorting a stock or two as a hedge. And most of all, avoid companies that use large amounts of debt. Their costs are going up

A Painful but Healthy Adjustment

money mazeMy Comments: Reassuring comments here from a trusted thinker on the markets. No guarantees but if you have at least a 5 year time horizon, we will be OK. Just don’t get caught up in the media rhetoric and the pointing of fingers. Almost all of it is stupid, ill informed, and self-serving. Life happens, and this is normal. Which is not to say there are no ways to continue making money.

August 24, 2015 by Scott Minerd

The recent global equity market selloff reflects a long-awaited—and I believe ultimately healthy—market correction. A number of commentators speculated that after Monday morning’s sharp decline in U.S. stocks, the intra-day reversal indicated that we reached a bottom. In the very short run, I would agree. However, longer term, neither fundamental nor technical data support that we have reached the levels of capitulation associated with the end of a market correction.

One example is the Chicago Board Options Exchange SPX Volatility Index (VIX), often referred to as the “fear” index. While it spiked significantly higher, the VIX still failed to stay at the levels normally associated with capitulation like those experienced in 2011. Over the coming days I expect the market will try to find some short-term footing, but I doubt we have found a bottom yet. Buying risk assets now would be like catching a falling knife—if you do so you are likely to get quite bloody in the short run.

The market rout has spawned numerous news stories attempting to explain the source of the sharp declines in global equities. Many have highlighted the decline in emerging markets, which, on balance, have now officially reached bear market territory, given the over 20 percent decline in the MSCI emerging markets index since April.
Some markets have done much worse, especially when measured in U.S. dollars. Brazil is the poster child for the ravages of a full-fledged bear market. Even with the devastating declines, emerging markets have yet to show any signs of bottoming based on either economic fundamentals or market technical indicators.

While in the U.S. fundamentals remain supportive of continued economic growth, technical indicators point to lower prices in U.S. risk assets. Looking at the S&P 500, the sudden collapse in prices should provide near-term support, but after some consolidation I would expect us to revisit the lows and ultimately test the 1,820 level. A decline to 1,820 on the S&P 500 would represent a 15 percent drop from the peak, which would be a healthy correction in a long-term bull market. As this correction plays out, I would expect yields on below-investment-grade energy credits to widen by another 200 to 300 basis points. Other equity markets and higher quality credit assets are likely to sell off in sympathy as well.

So what is causing all of this turbulence? The source is the massive misalignment of exchange rates, which finds its roots in quantitative easing. Case in point, consider Japan, which has weakened its currency by over 50 percent against the U.S. dollar, while China, Japan’s largest trading partner, has basically pegged the renminbi (RMB) to the dollar.

Strains on the terms of trade between countries that have devalued and those that have not have built to the point that perpetuating these disparities is destabilizing to the countries that have staunchly fought devaluation. Witness China’s recent move to devalue the RMB versus the dollar, proving that artificial equilibrium is not only impossible to maintain, but ultimately disruptive to markets and economic growth.

Now we are facing the turbulent path to a new equilibrium. The coming weeks will be difficult and it is hard to hazard a guess as to when and how this will all end. Nevertheless, I place great faith in governments’ willingness to use the printing press. It is a handy tool to prop up asset prices and temporarily spur economic growth. For that reason I don’t see recession on the horizon for the G-7 nations or China either.

In time, policymakers will react. I would assume that the reaction time is fairly short. No one seems inclined to test the limits of how far asset prices can fall. Yet, given the current bias by the U.S. Federal Reserve to raise rates and the Peoples’ Bank of China to support the RMB, some more time will need to pass before more dramatic action is taken.

I would suspect that this will all climax by late October, but only time will tell. For the time being more downside risks remain. As I have mentioned before, cash is king, treasuries will outperform, and patience is a virtue. I don’t believe we have reason for panic, but complacency is dangerous too. Look for opportunities and more signs of capitulation.

Financial Gravity

InvestMy Comments: It’s easy to get upset by what is happening to the stock market, the bond market, and trying to make sense of it all. You either quit thinking about it or try to get your brain around it so that it fades into the background. Or not.

Most think the crash of 2008-09 was caused by too many sub-prime home mortgage loans. We’re now looking at a glut of sub-prime auto loans and there’s likely to be a similar outcome.

My expectation is the Federal Reserve will finally start to raise interest rates. That’s going to be painful, but it has to happen, and the sooner the better. The following words come from a Porter Stansberry whose digest can be subscribed to. I find it far more helpful than a subscription to the Wall Street Journal.

“I believe that some combination of rising interest rates, rising defaults in the corporate bond market, and global currency/trade wars will likely cause the U.S. stock market to decline substantially. No, I don’t know the exact timing of such a move. But I believe it will happen within the next few months. Downward reversion to the mean will play a role.”

The Dow Jones Industrial Average has plunged more than 1,500 points since Porter wrote those words about six weeks ago. He followed them up with a detailed explanation a few weeks later in the August 14 Digest

For many years, subscribers have asked us (Stansberry Research) about the inflation/deflation debate. In our minds, there was never a debate. The greatest contribution the “Austrian” school of economics made to financial thought was the proper definition of inflation.

Most people, however, still do not understand that inflation isn’t necessarily the increase of prices according to an index. Often, credit inflations do not cause rising prices at all… They frequently cause falling commodity prices. The proper definition of inflation is the creation of credit in excess of savings and foreign investment. And by that definition, the Federal Reserve has initiated one of the greatest inflations in history.

The Fed has provided $4 trillion in additional credit to the U.S. Treasury. Saving didn’t create this credit. It was created out of thin air. That’s a perfect example of inflation. For the last six years, this immense amount of credit has artificially reduced the cost of capital across our entire economy – lowering it to almost zero. It’s as though the Fed suspended “gravity” in our economy. And not surprisingly, a boom erupted where this credit landed.

This cheap credit is responsible for the “Bernanke Asset Bubble” we’ve discussed many times. But it hit some areas of the economy particularly hard…

The two most popular beliefs in the credit markets back in 2009 guided where most of the credit went. Back then, even sophisticated people on Wall Street (including Warren Buffett and GMO Financial founder Jeremy Grantham) genuinely believed we were running out of oil.

The performance of car loans during the crisis had convinced lenders that consumers wouldn’t default on car loans because they had to have the vehicles to get to work. (The line back then was that you couldn’t drive your house to work, so you’ll default on your mortgage, but not on your car loan.) A related trend was the government’s efforts to essentially guarantee all student loans. Presto… the credit flowed there, too.

In the short term, these policies have stimulated our economy. Texas led employment growth following the last recession. Outside of employment related to oil investments, employment hasn’t grown at all in the U.S.

Likewise, the two other booming areas of our economy have been auto sales (which neared an all-time high last year with 17 million new cars sold) and capital investment in higher education. Drive through any major university and you will see plenty of cranes. It’s no surprise that the only forms of consumer credit that have grown since 2009 are student loans and car loans. Total outstanding car loans just passed $1 trillion for the first time ever.

While the result has been an economic boom, Porter says it’s due to a “phony” signal. And it encouraged a lot of investing and borrowing that otherwise never would have happened without cheap credit.

Or as Porter put it, with financial “gravity” near zero (super-low capital costs), almost anything will “fly.” But when gravity returns, these same “investments” will head back to earth in a hurry…

A lot of the money invested in the oil business, for example, has gone into projects (like the oil sands) that aren’t economic and aren’t likely to be in a lifetime. A lot of cars were built and sold to people who can’t actually afford them. These people will eventually default. Sooner or later, soaring car loan defaults will drive down the prices of used cars, making it difficult to sell new ones at a profit.

That’s the downside to a phony boom. Since these investments weren’t financed with actual savings, there won’t be enough demand to sustain the debts that have been created. You can think of savings and investment as a see-saw. Without roughly the same amounts on either side, you’re going to have a problem.

For the last six years, that has meant our economy was on “tilt” in a way most people think of as positive: Huge investments in oil, plenty of credit for consumers. Now, the opposite kind of “tilt” looms right in front of us. The boom, as it was not financed with savings, will surely lead to a bust of similar magnitude.

Some folks have questioned why we’ve been following the oil sector so closely. This is why…  As Porter explained, problems in the oil sector are likely to be one of the big reasons for the return of higher capital costs…

Both car loans and oil investments are beginning to sour. These poor investments and poor lending decisions involved hundreds of billions of dollars in bonds and loans that have been packaged into bond-like securities. The worsening performance of these debts will eventually “spill over” into other areas of the bond market.

Here’s how Bank of America high-yield credit strategist Michael Contopoulos explained the situation in a recent report…

We think we’re seeing a pattern very similar to the late ’90s emerge today. High yield typically overbuilds in one industry before realizing stress in that sector – think telecom then, commodities now. Over time, this develops into a risk aversion that spills into the broader market.

The stress has yet to make a meaningful impact to non-commodity sectors, but we view this lack of movement not as a positive, but just a delay of the inevitable. With heightened sensitivity to earnings, coupled with rate risk and further commodity weakness, we think poor fundamentals and demand for higher compensation for illiquidity will soon be reflected in prices.

Porter recommended keeping a close eye on high-yield bonds for clues on what’s coming next…

As I’ve been warning since 2013, the high-yield bond market reached completely unsustainable levels thanks to the Fed’s massive credit inflation.

As this credit bubble deflates, “gravity” will return to our economy. Capital costs will begin to grow. Terms for credit will get tougher. The rising cost of capital will result in bad loans, bankruptcies, repositions, unemployment, softer demand, and lower securities valuations. Winter is coming, friends.

You can see commodity-related credit defaults have begun to hurt the market for high-yield bonds. Record levels of subprime auto loan defaults will be next…

Regards,

Justin Brill
Baltimore, Maryland
August 24, 2015

Pressure Mounts on China

Nixon+ChinaMy Comments: None. This speaks for itself.

Commentary by Scott Minerd, Chairman of Investments and Global CIO, Guggenheim Partners, August 21, 2015

More bad news out of Asia: Chinese manufacturing conditions are back at the same levels as they were at the height of the financial crisis in 2009, a clear sign that China’s economy is slowing.

The preliminary Caixin China purchasing managers’ index (PMI) fell to a 77-month low of 47.1 in August, down from July’s final reading of 47.8. Any index reading below 50 represents a contraction. The data had an immediate effect on local markets—the Shanghai Composite Index dropped 4.3 percent to its lowest level since July 8—and China’s fragility will do nothing to shore up confidence in global markets.

We all know the dramatic steps that were necessary to revive the Chinese economy in 2009—a 4 trillion renminbi (RMB) stimulus package, equivalent to about 12 percent of China’s annual gross domestic product (GDP) at the time. China will need to take drastic action again, and to a greater degree than it has done in recent weeks.

The challenge is that attempts by the People’s Bank of China (PBoC) to inject liquidity are being sterilized by offsetting sales of reserve assets to stem a more dramatic slide in the exchange value of the RMB. This limits the impact of actions to increase monetary liquidity as is evidenced by the recent unintended rise in short-term rates in China.

As a result, the PBoC will soon be forced to reduce bank reserve requirements while allowing for a more rapid devaluation of the RMB. Time is not on the side of Chinese policymakers. Given the severity of the current domestic slowdown, pressure is mounting for more radical policy action.

Expect to see further downward pressure on commodity prices, global equities, and U.S. Treasury yields. The first sign that we are approaching a bottom for all three will be when China caves and allows the RMB to adjust to a more appropriate level, which could mean another 25–30 percent decline in the value of the RMB against the U.S. dollar.

Things will get worse before they get better, and investors around the world are demonstrating appropriate concern. Unfortunately, relief is nowhere in sight.

Saudi Arabia May Go Broke Soon

My Comments:  If Saudi Arabia ceases to function and Iran has a nuclear weapon, what are the implications for the rest of the world?

I accept that I’ll be just a memory by 2045. However, the United States may then be the only country on the planet with the ability to both unilaterally feed itself and produce 100% of the energy it needs. Food and fuel are as critical today as they were millennia ago.

Yes, there are environmental reasons to oppose fracking anywhere in the world but you have to admit the technology has the potential to dramatically change existing global economic and political dynamics.

How all this plays out politically with concurrent changes to existing global security arrangements is yet to be seen. It helps explain Russia’s recent moves to be more aggressive and paranoid about their future. As for Saudi Arabia, without oil to pump, they become a ghost town. We need to think about all this as we argue for or against the pending Iran nuclear deal.

By Ambrose Evans-Pritchard 05 Aug 2015

If the oil futures market is correct, Saudi Arabia will start running into trouble within two years. It will be in existential crisis by the end of the decade.

The contract price of US crude oil for delivery in December 2020 is currently $62.05, implying a drastic change in the economic landscape for the Middle East and the petro-rentier states.

The Saudis took a huge gamble last November when they stopped supporting prices and opted instead to flood the market and drive out rivals, boosting their own output to 10.6m barrels a day (b/d) into the teeth of the downturn.

Bank of America says OPEC is now “effectively dissolved”. The cartel might as well shut down its offices in Vienna to save money.

If the aim was to choke the US shale industry, the Saudis have misjudged badly, just as they misjudged the growing shale threat at every stage for eight years. “It is becoming apparent that non-OPEC producers are not as responsive to low oil prices as had been thought, at least in the short-run,” said the Saudi central bank in its latest stability report.

“The main impact has been to cut back on developmental drilling of new oil wells, rather than slowing the flow of oil from existing wells. This requires more patience,” it said.

One Saudi expert was blunter. “The policy hasn’t worked and it will never work,” he said.

By causing the oil price to crash, the Saudis and their Gulf allies have certainly killed off prospects for a raft of high-cost ventures in the Russian Arctic, the Gulf of Mexico, the deep waters of the mid-Atlantic, and the Canadian tar sands.

Consultants Wood Mackenzie say the major oil and gas companies have shelved 46 large projects, deferring $200bn of investments.

The problem for the Saudis is that US shale frackers are not high-cost. They are mostly mid-cost, and as I reported from the CERAWeek energy forum in Houston, experts at IHS think shale companies may be able to shave those costs by 45pc this year – and not only by switching tactically to high-yielding wells.

Advanced pad drilling techniques allow frackers to launch five or ten wells in different directions from the same site. Smart drill-bits with computer chips can seek out cracks in the rock. New dissolvable plugs promise to save $300,000 a well. “We’ve driven down drilling costs by 50pc, and we can see another 30pc ahead,” said John Hess, head of the Hess Corporation.

It was the same story from Scott Sheffield, head of Pioneer Natural Resources. “We have just drilled an 18,000 ft well in 16 days in the Permian Basin. Last year it took 30 days,” he said.

The North American rig-count has dropped to 664 from 1,608 in October but output still rose to a 43-year high of 9.6m b/d June. It has only just begun to roll over. “The freight train of North American tight oil has kept on coming,” said Rex Tillerson, head of Exxon Mobil.

He said the resilience of the sister industry of shale gas should be a cautionary warning to those reading too much into the rig-count. Gas prices have collapsed from $8 to $2.78 since 2009, and the number of gas rigs has dropped 1,200 to 209. Yet output has risen by 30pc over that period.

Until now, shale drillers have been cushioned by hedging contracts. The stress test will come over coming months as these expire. But even if scores of over-leveraged wild-catters go bankrupt as funding dries up, it will not do OPEC any good.

The wells will still be there. The technology and infrastructure will still be there. Stronger companies will mop up on the cheap, taking over the operations. Once oil climbs back to $60 or even $55 – since the threshold keeps falling – they will crank up production almost instantly.

OPEC now faces a permanent headwind. Each rise in price will be capped by a surge in US output. The only constraint is the scale of US reserves that can be extracted at mid-cost, and these may be bigger than originally supposed, not to mention the parallel possibilities in Argentina and Australia, or the possibility for “clean fracking” in China as plasma pulse technology cuts water needs.

Mr Sheffield said the Permian Basin in Texas could alone produce 5-6m b/d in the long-term, more than Saudi Arabia’s giant Ghawar field, the biggest in the world.

Saudi Arabia is effectively beached. It relies on oil for 90pc of its budget revenues. There is no other industry to speak of, a full fifty years after the oil bonanza began.

Citizens pay no tax on income, interest, or stock dividends. Subsidized petrol costs twelve cents a litre at the pump. Electricity is given away for 1.3 cents a kilowatt-hour. Spending on patronage exploded after the Arab Spring as the kingdom sought to smother dissent.

The International Monetary Fund estimates that the budget deficit will reach 20pc of GDP this year, or roughly $140bn. The ‘fiscal break-even price’ is $106.

Far from retrenching, King Salman is spraying money around, giving away $32bn in a coronation bonus for all workers and pensioners.

He has launched a costly war against the Houthis in Yemen and is engaged in a massive military build-up – entirely reliant on imported weapons – that will propel Saudi Arabia to fifth place in the world defence ranking.

The Saudi royal family is leading the Sunni cause against a resurgent Iran, battling for dominance in a bitter struggle between Sunni and Shia across the Middle East. “Right now, the Saudis have only one thing on their mind and that is the Iranians. They have a very serious problem. Iranian proxies are running Yemen, Syria, Iraq, and Lebanon,” said Jim Woolsey, the former head of the US Central Intelligence Agency.

Money began to leak out of Saudi Arabia after the Arab Spring, with net capital outflows reaching 8pc of GDP annually even before the oil price crash. The country has since been burning through its foreign reserves at a vertiginous pace.

The reserves peaked at $737bn in August of 2014. They dropped to $672 in May. At current prices they are falling by at least $12bn a month.

Khalid Alsweilem, a former official at the Saudi central bank and now at Harvard University, said the fiscal deficit must be covered almost dollar for dollar by drawing down reserves.

The Saudi buffer is not particularly large given the country’s fixed exchange system. Kuwait, Qatar, and Abu Dhabi all have three times greater reserves per capita. “We are much more vulnerable. That is why we are the fourth rated sovereign in the Gulf at AA-. We cannot afford to lose our cushion over the next two years,” he said.

Standard & Poor’s lowered its outlook to “negative” in February. “We view Saudi Arabia’s economy as undiversified and vulnerable to a steep and sustained decline in oil prices,” it said.

Mr Alsweilem wrote in a Harvard report that Saudi Arabia would have an extra trillion of assets by now if it had adopted the Norwegian model of a sovereign wealth fund to recyle the money instead of treating it as a piggy bank for the finance ministry. The report has caused storm in Riyadh.

“We were lucky before because the oil price recovered in time. But we can’t count on that again,” he said.

OPEC have left matters too late, though perhaps there is little they could have done to combat the advances of American technology.

In hindsight, it was a strategic error to hold prices so high, for so long, allowing shale frackers – and the solar industry – to come of age. The genie cannot be put back in the bottle.

The Saudis are now trapped. Even if they could do a deal with Russia and orchestrate a cut in output to boost prices – far from clear – they might merely gain a few more years of high income at the cost of bringing forward more shale production later on.

Yet on the current course their reserves may be down to $200bn by the end of 2018. The markets will react long before this, seeing the writing on the wall. Capital flight will accelerate.

The government can slash investment spending for a while – as it did in the mid-1980s – but in the end it must face draconian austerity. It cannot afford to prop up Egypt and maintain an exorbitant political patronage machine across the Sunni world.

Social spending is the glue that holds together a medieval Wahhabi regime at a time of fermenting unrest among the Shia minority of the Eastern Province, pin-prick terrorist attacks from ISIS, and blowback from the invasion of Yemen.

Diplomatic spending is what underpins the Saudi sphere of influence in a Middle East suffering its own version of Europe’s Thirty Year War, and still reeling from the after-shocks of a crushed democratic revolt.

We may yet find that the US oil industry has greater staying power than the rickety political edifice behind OPEC.

A Death Blow To An American Industry

oil productionMy Comments: I rarely post on the weekend, but since it’s August and many of us are driving somewhere for a few days, this seems relevant. It’s mostly about the money we pay for gas these days at the pump. But there will be significant ripples across the planet as this plays out.

While a roomful of economists will have totally divergent ideas, Harry Dent is the one who predicted the DOW at 20,000 some 20 years ago. He has a very solid resume. As for me, I’d just as soon pay less to fill up the car and worry about something else these days.

Aug. 7, 2015, by Harry Dent

Summary

  • Why oil’s bounce will not be as big this time around.
  • The impact QE has had on the oil industry.
  • More about the greater global slowdown that lies ahead.

Oil is on a course to test its $42 lows from March, as I’ve said it would. And the way it’s been falling lately, I wouldn’t be surprised if it happens in the next couple of weeks.

There are several ramifications to this. In the long term, it will devastate the global economy as shrinking demand wipes out oil players and oil jobs around the world. But in the short term it will affect the U.S. more — possibly more than any other country — striking a death blow to the fracking industry, specifically because it’s become such a staple of our bubble economy and recovery.

Many are quick to think that since oil bounced back in recent months it will do so again. We did say it would bounce, and it did just that — bouncing back to $63, right in our target range of $62 to $74. But I don’t expect it to bounce for long this time around. John Kilduff from Again Capital shares our view. That’s because the world is quickly becoming a different place. The bubble euphoria investors have enjoyed since 2008 is showing several signs that it cannot continue.

And since the fracking industry is one of the highest cost producers and nothing more than a mirage created by QE economics, it might well be one of the triggers for what could become the greatest crash of our lifetime. Fracking had been around for a while before it really took off in the last decade. Its large upfront costs had made it impossible for it to become a leading player in the oil industry.

But the zero-interest rate policies launched by the Fed and other central banks suddenly caused junk bonds to drop to more affordable levels. Yields that were once 10% fell to 5.5%. So the frackers swooped in, jolting their industry forward like a shot straight to the heart.

Along with the global economy, QE propped up the oil industry — lifting it off its 2008 low of $32 (which would’ve been much lower if QE hadn’t come into the picture) to the early 2011 high of $115. Fracking could exist in that environment. At today’s prices, it can’t.

I don’t know how else to say it — without QE, it’s a mirage. An illusion. Totally artificial. And like the trillions that are about to disappear from the world, it’s like magic. Now you see it, now you don’t.

The way oil prices are falling — and the way the global economy is displaying greater signs of weakness — you can bet that fracking is doomed! Its breakeven cost is around $65 — and between $55 and $80 for most producers. That’s to say nothing of profits and long-term sustainability as a business! With oil below $42, frackers have no hope, and a mountain of debt they can’t repay.

Beyond that, there are two key reasons oil will not return to the more profitable mark of $80-plus for at least a decade. Kilduff and I agree here as well. There is no government or central bank supporting the fall of oil like they are stocks and bonds. Saudi Arabia, the largest producer that also pumps oil the cheapest, is hell-bent on wiping out its competition by churning out more and more oil to feed the supply glut.

They will stop at nothing to achieve this — and since they don’t see the huge falloff in demand ahead that we see globally, the Saudis will keep pumping even at the expense of their own government budget. The other reason is that when all this global stimulus starts to unravel, demand for oil will fall at an unexpected rate. We’re talking $30 by Christmas time, as Kilduff said on CNBC Squawk Box recently. I’ve been saying $32 by late January, but John is the ultimate expert in this sector.

That said, it’s very possible and likely that oil could bounce after touching a $30 to $32 bottom in the months ahead — once fracking stops adding to the supply glut. You’d be surprised just how big a contributor this industry has been to this bloated oversupply in oil. Just look at how many rigs belong to fracking or “horizontal” drilling:

That should make it very clear that the death of fracking will wipe away most of the oil supply and return it to more ordinary levels. And it will crush the American energy industry. But the larger issue is what follows: a greater global slowdown that’ll unfold in the latter part of this decade. That will absolutely crucify global demand for oil!

Governments won’t see this coming — not ours, not Saudi Arabia’s. Central banks will be kidding themselves if they so much as try to stop it. They can’t buy oil with any credibility as they have their own “safer” bonds. This is one free market force that will shoot to kill.

PPACA Premiums to Rise 4% in California

health-is-wealthMy Comments: During my 40 years as an insurance agent, I sold my share of health insurance policies. Over these years, it  became normal to see annual premium increases of 6% to 8% every year. These increases were driven primarily by Big Pharma (the drug industry) and by hospitals. For them it was the cost of new technology, demanded by physicians and patients alike, and by the huge number of uninsured people who used emergency rooms whenever they needed medical care. The cost of that care fell on those of us paying insurance premiums.

California adopted the system we’ve come to know as Obamacare, and while it has its flaws, put pressure on many of the egregious elements in the existing system to find remedies to control costs.

The premium increases described in this article are a strong step in the right direction. Too bad no one in Tallahassee had the ability adopt these strategies for those of us living in Florida. The crap and lies promoted by Fox News and the brotherhood called the GOP means the benefits of lower premium increases will fall somewhere else.

Jul 28, 2015 | By Jack Craver

The PPACA marketplace in California has announced that premiums for plans on its exchange will rise by 4 percent next year, far lower than dramatic premium increases in certain areas detractors have highlighted to argue the new system isn’t working.

Supporters of the Patient Protection and Affordable Care Act are pointing to costs of health care in the nation’s most populous state as evidence that the law is working as intended, reports The Hill.

The 4 percent rise is slightly lower than the 4.2 percent increase that Golden State saw this year and is consistent with the average national increase projected in a study last year by the McKinsey Center for Health Care Reform.

“This is another year of good news for California’s consumers and further evidence that the Affordable Care Act is working,” Peter Lee, executive director of Covered California, told The Hill.

The announced rates are not final, and must still be reviewed by the state’s insurance commissioners. In recent months, President Obama and others in his administration have emphasized that insurers with plans in state and federal exchanges are expected to explain any proposed premium increases.

In a recent letter to state insurance commissioners urging close examination of premium hikes, the CEO of the federal Health Insurance Marketplace, Kevin Counihan, argued that recent economic and political developments should prevent high premiums.

More healthy, young people are joining the exchanges and the federal government last month expanded a government-backed “reinsurance program” designed to protect health insurers from extremely high claim costs, Counihan wrote. The HHS will pay 100 percent of claims costs between $45,000 and $250,000 for insurers who pay into a national pool. Counihan also pointed out that overall medical costs have remained “moderate” in the past year, despite a big rise in the price of pharmaceuticals.

“Based on preliminary filings for the coming year, we are confident that, overall, consumers will retain access to a wide range of affordable options in 2016,” wrote Counihan.