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Over the course of the past week, our quantitative models on commodities have gone from a bearish formation for oil to a bullish formation.  Fundamentally, there are a number of factors that have been driving this change in quantitative set up.

First, geopolitical tensions seem to be picking up on the margin.  In recent weeks, Vladmir Putin has visited with Hugo Chavez and President Karzai of Afghanistan has made a number of anti-Western comments, in addition to reaching out to Iran and China.  This morning, as well, the river card was shown in the way of increased terrorist activities in Pakistan.  A U.S. consulate was attacked in Pakistan and another related bombing killed 25 people in Pakistan.

Second, there is increasing evidence that slack in the global economy will tighten for more than just the short term, which improved the global demand picture for oil.  As we highlighted in our oil Black Book last year, supply globally is tight despite massive investment over the last decade.  Therefore, when projecting for the tightness of supply and demand, the key factor to solve for is a pick up in demand.  In the short term, pundits will point to the most recent relevant data point from the United States - the better than expected jobs report which added 162,000 jobs.  More important though is the sustained growth from Asia, most notably China. 

One of our key themes for Q1 2010 was Chinese Ox in a Box, with which we accurately predicted a correction in Chinese equities.  While we did see a slow-down in various economic data points in Q1 for China, we also see continued demand for commodities, which most directly support sustained demand for oil. Specifically, on March 23rd, we wrote in the Early Look:

“Vale is the second largest mining company in the world, so when Vale speaks, our commodities team listens.  Last night Vale sent a document to its customers saying it was raising iron ore prices to $122.20 per tonne, versus $57 per tonne year last year.  That is a 114% increase.  I don’t need a degree from MIT to know that is inflation.”

In the chart below, we have highlighted the long term oil import trends for the Chinese, suffice it to say, they are up and to the right:

Oil Prices Rule - China Crude Oil Imports

Finally, days supply of oil in the United States continues to trend below year ago levels, as it did for much of February and March. While there are currently 25.2 days’ supply in the United States, it is below last year’s level from the same week by 0.2 days.  Including the Strategic Petroleum Reserve, however (this is above historical levels), the aggregate supply level in the United States continues to be at improved levels versus last year.

Predicting the direction of the price of oil globally is no easy task.  It requires a global supply and demand analysis, and also an incorporation of a varying number of factors, which change with time (as an example the inverse correlation to the U.S. dollar has become slightly less relevant versus last year).  Nonetheless, as with most markets, prices rule, and the prices, combined with the fundamentals on the margin, are suggesting a bullish set up for oil.  Our immediate term price levels are outlined below:

Oil Prices Rule - OIL

Daryl G. Jones

Managing Director