This note was originally published at 8am on February 18, 2015 for Hedgeye subscribers.
“Shallow men believe in luck or in circumstance. Strong men believe in cause and effect.”
-Ralph Waldo Emerson
If you are human, when the global macro market correlations go against your position, you undoubtedly classify them as spurious. After all, they don’t fit your thesis, so how else can they be classified?
In reality, when we think of spurious correlations, we think of things that have no business or rationale in being correlated. We’ll give you a few examples:
- From 1990 to 2009, the inverse correlation between honey producing bee colonies in the U.S. was -0.93 inversely correlated to juvenile arrests for marijuana;
- From 1990 to 2010, the positive correlation between people who drowned falling out of a fishing boat in the United States with the marriage rate in Kentucky was +0.95;
- And last but not least . . . from 2000 to 2009, the per capita consumption of mozzarella cheese was +0.96 correlated with civil engineering doctorates awarded in the United States.
Suffice it to say, not all correlations are created equal.
In yesterday’s Early Look, Keith highlighted the fact that some of our macro views that are highly correlated have been going against us for the last week or so – dollar down, oil up, Euro up, Russia up, Greece up, Brazil up . . . and the list goes on. Versus say mozzarella and engineering degrees, these assets, even if we disagree with their recent price direction, have a lot more business being correlated.
Certainly, almost every asset and asset class has a price, but what we have seen in February remains a counter TREND move. In our view, the underlying fundamental circumstance of global #deflation and slowing growth remains intact.
Back to the Global Macro Grind...
Speaking of spurious, the most interesting central banking comments of the day award has to go to Bank of Japan Governor Kuroda, who indicated he will potentially act if the drop in the price of oil continues to hurt his outlook for inflation and general price levels (read: his inflation statistics). Since the Bank of Japan has bought almost every other asset available globally, perhaps the next move will be to lever up and buy oil futures!
On the topic of oil and counter trend moves, oil continues to be one of the more hotly contested asset classes globally. After a decline of epic proportions, WTI is now up about 10% in the last month and this is, admittedly, on contract volume that is up about 61% versus the 3-month average. Certainly, declining rig count in the U.S. and some level of short covering has helped, but what of production and future supply? Interestingly, Wood Mackezie in a recent report noted the following per a Bloomberg article:
“. . . that of 2,222 oil fields surveyed worldwide, only 1.6 percent would have negative cash flow at $40 a barrel. That suggests there won't be a lot of chickening out at $40. Keep in mind that the marginal cost for efficient U.S. shale-oil producers is about $10 to $20 a barrel in the Permian Basin in Texas and about the same for oil produced in the Persian Gulf.”
In Chart of the Day, we highlight weekly U.S. oil production in the U.S. going back to 1983 (as long as the data has been kept). As you can see, weekly oil production in the U.S. hit its highest level in more than 32-years last week. If Wood Mackenzie is correct, it seems we may not be done with #DrillBabyDrill just yet.
Inasmuch as oil bears want the bottom to be in for WTI, the chart is very telling. Not only is oil production at a 32+ year high in the U.S., it is growing some 10% year-over-year. Unfortunately, again for oil bulls, on the demand side, the outlook is not overly robust either, with U.S. oil demand at a more than 12-year low (as a % of GDP).
The nearest term catalyst for oil markets may well be in the April / May time frame in the U.S. Based on projections of current production, it is expected that Cushing, and other U.S. repositories, may be at full capacity by then. In theory, this may force producers to dump near term supplies on to the market at seriously discounted prices. #Contango, anyone?
Switching commodity gears slightly, at 11am ET this morning, we will be hosting a call with Keith Barnett the Head of Fundamental Analysis from Asset Risk Management (http://asset-risk.com/author/kbarnett/ ) on the outlook for natural gas prices (he will also discuss oil). If you don’t already have it and would like to get the dial in for the call, please email email@example.com. The key topics Barnett will discuss include:
- Rapid growth in US production driven primarily by emergence of Marcellus / Utica shale play has created basis price dislocations as infrastructure and demand re-calibrate to new supply / demand regional balances;
- Demand growth along the US Gulf Coast [industrial, LNG exports, and pipe exports to Mexico] create a “battle zone” for basis differentials to re-balance in 2016-2020, with the Haynesville waiting in the wings;
- British Columbia / Northern Alberta shale plays will look for a home, especially if BC LNG exports continue to be delayed and lower crude prices dampen oil sands (gas demand) development; and
- Lower crude prices will affect the supply side through reduced liquid-oriented gas, and the demand side by impacting petchem plant development, global LNG price arb, and Mexico project development.
We hope you can join the call.
Our immediate-term Global Macro Risk Ranges are now:
UST 10yr Yield 1.70-2.18%
Oil (WTI) 48.37-54.02
Keep your head up and stick on the ice,
Daryl G. Jones
Director of Research