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Money Monitor: Paper Reflation Hitting an Oil Slick?


With the emerging markets coming under increasing pressure, we remain on watch for a more serious downside correction in the US equity market...


From the General Manager of the Bank of International Standards (BIS), Malcom Knight:

"At some point central banks may well have to act more forcefully on policy rates than they have needed to in the past few years. Inflation risks are now seen to be greater than they have been for some time."

Within that context we shift focus to the southeast, and data released on Monday in China detailing 'implied oil demand' based on calculations derived from trade data and domestic oil output figures, as compiled by Reuters for the month of May:

  • Crude Oil Imports up +20.5% yr-yr in May, re-accelerating, and spiking into positive territory from the (-) 1.8% yr-yr contraction posted in April.
  • Domestic Crude Oil Supplied up + 9.7% yr-yr in May, accelerating from the rise of +2.6% yr-yr posted in April.
  • Product Imports up +416.3% yr-yr, not a typo, up four hundred and sixteen-plus percent, soaring further from the already stratospheric pace of increase posted in April, at +69.5% yr-yr.


  • Implied Chinese Oil Demand up +13.5% yr-yr in May, expanding from +10.8% yr-yr growth posted in April, and representing the fastest pace of demand growth in over eighteen months, since the end of 2004.

Bottom Line: Chinese energy demand is surging, again.

Bottom Line: This is a trend, one that is now accelerating/intensifying.

Evidence the Jan-May YTD rise in Net Product Imports, which is now pegged at more than 35.0 million barrels.

And it gets even more interesting, when we include Fuel Oil, imports of which soared by more than fifty percent on a year-year basis to an 11-month high of 2.48 million tonnes, amid a move by utilities to replenish depleted supplies.

And, in India, we note the most recent inflation data, released late Friday:

  • India, Headline Wholesale Price Index up + 5.24% yr-yr in the week ending June 10, a steep increase from last week's + 4.72% yr-yr rate, pushing it above five percent, and to its highest level in well over a year.

Subsequently, the yield on the benchmark 10-Year Indian Bond rose +6 basis points on Monday to hit its highest level since May of 2002. In other words, the Indian Bond yield just hit a four-year high at 8.19%.

Indeed, talk of another BOI rate hike (last hiked +25 bp to 5.75% on June-8) is in the air, in synch with similar talk emanating more vocally from within Chinese officialdom. Indeed, evidence comments made this morning in Basel by People's Bank of China Governor Zhou Xiachuan:

"The economy is doing well. We are going to have some policy adjustment and also tightening a little bit in monetary policy."

When asked about the currency, Zhou commented:

"I think that domestic equilibrium, domestic stability, and currency stability are always more important considerations than international considerations."

Hhhhmm, with crude oil and energy product imports soaring, the CNY hitting a brick wall of appreciation-resistance at the 8.00 level and the European inflation data suggesting that price pressure has hit a critical-mass point -- pass-thru wise from the energy-led PPI push, to pressure in consumer goods -- it makes us wonder.

Note the plethora of data from the Eurozone in the last 24 hours (Spanish PPI, German States CPI, German WPI, German Import Prices, Swedish PPI, and Portuguese PPI) and a new high in Indian inflation rates and intensified talk of a more rapid rise in short-term interest rates from the Bank of India, what might happen -domestic equilibrium-stability wise - in all of these places, IF the energy markets, particularly the product markets, begin to tighten from here, with prices having maintained historically high levels with nary a significant downdraft?

With that question in tow, we shine the spotlight on something happening in the Gasoline market, something we have heard virtually no discussion about, as evidenced in the chart below, amid a tightening in the forward calendar spreads traded on the NYMEX.

The winter seasonal spreads in Gasoline, not Heating Oil or Natural Gas, are threatening to move into backwardation, as pictured in the first chart on display below.

If the spectacular move in the fall-seasonal spreads is any indication of what is to come in the winter, then we might expect year-round tightness, and continued underlying support for prices to remain above $2. More succinctly, the explosive move into a steep and steepening backwardation by the Oct-Dec spread suggests that a move towards even higher flat-prices is becoming more probable.

Telling is the fact that the long-term trend in supply remains to the downside, as exhibited in the mega-macro-monthly chart seen below, plotting the 24-Month Moving Average of Total US Mogas Supplies, in millions of barrels. Moreover, the MA turned down towards the end of last year, and has been in decline throughout 2006 and has fallen below 205 mb...

...despite record high domestic output of Gasoline, as noted in the chart on display below, plotting the breakout revealed by last week's data.

As per the API data released last week we note that the yr-yr supply deficit in Gasoline widened to (-) 3.8 mb from the previous week's 3.4 mb deficit. Moreover, the decline came on the back of a plunge in East Coast supply, which plummeted in the latest week to 56.4 mb from 60.2 mb.

Observe Gasoline's resilience in terms of sustaining a price level above the $2 per gallon level in the daily close-only chart on display below

Clearly, a push back above $2.25 would be bullish, technically.

Perhaps part of the reason for Gasoline's resiliency can be traced back to the fact that on a relative basis, as per a straight ratio perspective, gasoline is cheap, still, and to a near historic degree compared to Crude Oil. Evidence the long-term plot of the 52-Week EXP Moving Average of the simple Ratio Spread between Gasoline and Crude Oil (NYMEX front-month continuous).

As we have suggested previously, a strategy of buying Gasoline and selling Crude Oil has fundamental merit, in our opinion.

And finally, we observe the dynamic that few are taking notice of, as energy prices remain high, having been relatively immune from the disinflation that has taken place in precious metals, base metals, emerging markets, and global equity markets, evidenced in the chart below, as the 'value' of paper wealth holdings continues to erode on a 'real,' 'relative' basis, when compared to energy, and, is now on the verge of a fresh breakdown to new bear-move 'lows.'

On a longer-term basis, we view the same action as defined by the S&P 500 Index and its ratio to Gasoline prices, shown in the weekly chart dating back to the late eighties. A breakdown of the long-term uptrend, a negative MA dynamic, and now newer new multi-year lows in paper.

Using Crude Oil again, and taking the mega-macro-monthly view as seen in the chart below … we note not only the new secular low in paper relative to oil, but more 'tellingly' we specifically focus on the long-term 5-Year Rate-of-Change indicator, which has been negative since 2002.

This implies that, at best, on a relative basis, the US public has only been treading water, from a macro-financial perspective, since the tech-bubble ended.

And, while hundreds of billions of dollars in MEW (mortgage equity withdrawal), and hundreds of billions of dollars in fiscal pork have helped keep the US consumer afloat, when we incorporate the rise in interest rates, as per our chart above, we get the Yield-Adjusted version of the S+P/Crude Oil Ratio Spread, shown in the mega-macro-monthly chart below.

Clearly the path of least resistance in paper wealth is lower now, as is evidenced in the chart seen below, in which we extract just the 5-Year Rate-of-Change indicator from our last chart (Yield Adjusted S+P/Crude Oil Ratio Spread, Monthly).

We might use this ROC as a proxy for the secular trend in paper wealth reflation, relative to energy price inflation.

In this case, the 'real' value of paper wealth is already, and has been since the beginning of 2004, deflating.

We wonder, when might the nominal value of paper wealth play catch up and synchronize with the erosion that is already evident, on a real basis?

With the emerging markets coming under increasing pressure, particularly as relates to many of the highest flying peripheral currency and stock markets (we detail this dynamic in tomorrow's Money Monitor) and the energy markets exhibiting signs of tightening, from both a technical and fundamental perspective, we remain on watch for a more serious downside correction in the US equity market and continued downside leadership in those peripheral emerging market currencies.

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