Oil

What does oil really cost to get out of the ground? $2/barrel. Where's peak oil? This is what the Iraqi oil service contracts have shown the world.

Under the service contracts, the companies would be paid a per barrel fee for any crude they produce in excess of a minimum production target. The Exxon Mobil-led consortium requested $4.8 per barrel for production over the minimum and BP wanted $3.99 per barrel, Oil Minister Hussain al-Shahristani said. The ministry was willing to pay $2 per barrel.

BP agreed to match the ministry's price and won the contract for Rumaila.

Peak oil is a scam. There's tons of the stuff out there. But on the other hand, it's not in the US, and it's not in a safe place. Still, 35X production costs is a steep margin.

In other news, Germany is losing control of the ECB. They were against the latest money pumping. The weaker nations of Europe are forcing the ECB to devalue the Euro against German opposition.

As judging by today's 100 point drop after disappointing consumer confidence #'s, it looks like the market is back to paying more attention to the bad news again. I might have to sell my oil position.

Mish has an article about Pilgrim's Pride, the chicken company that declared bankruptcy last year. Unfortunately for the town that was home to one of the closed factories, Pilgrim's Pride is loath to sell. With no pricing power, they don't want to have to compete against their own plant. This makes sense. It's also why they closed the plant in the first place.

Trade

Bought 45 (5%) DIG (Ultra Oil) at $26.65. Why? Because Bernanke announced yesterday that he sees no inflation. Which means, in my opinion, that the trend of rising oil will continue. If the economy doesn't recover quickly, he will print more money.

Mish was wondering what Bernanke would devalue the dollar against now that it's not backed by gold, as in the 30's. My answer is Treasuries. There's a big difference between the U.S. and Japan, regarding government borrowing and the inflation/deflation scenario. Japan financed their debt domestically. We have financed it internationally. That's why Bernanke will continue to devalue the dollar against Treasuries.

Therefore, I predict that the inflation/deflation debate will continue to rage, because imported goods will rise with dollar devaluation, while domestic goods and wages fall in price.

I also see gold as a good investment. If I buy more, it will probably be through FCX.


In other news, California announced that they will have to start issuing IOU's (again) starting July 2. The state legislature is gridlocked as they are unable to pass $8.6 billion in cuts. I'm not surprised. Democrats are afraid to cut and piss off their constituents. Republicans won't raise taxes. So neither side does anything. They only keep trumpeting what they WON'T do.

Another sign of dollar devaluation backfiring: ECB money printing and China's export restrictions. Both of these can be viewed as competitive devaluations.

The State of the Euro

The global financial structure is tottering again. China's and Japan's exports got worse in May, possibly because of the success of dollar devaluation.

The Russian stock market as fallen 24% since June 1st.

Now the FT reports that the ECB Pumps Record E442bn into System. This was in one-year funds. That means that the central banks don't see any inflation for a year. This looks like it's equivalent to quantitative easing for all practical purposes.

Maybe my Euro short will work out after all. This is also my only current play on dollar strength.

Where are the Green Shoots?

Bloomberg reports Japan Export Slump Deepens, Casting Doubt on Recovery. Exports dropped almost 41% yoy in May, and 0.3% from April.

I fully expect that the Fed will continue printing money, and that will cause Treasuries to fall and oil to rise (eventually). In the meantime, we're seeing oil weaken and Treasuries get stronger.

I don't want to be against the long-term trend. So, I need to be patient and wait.

Another sign of global economic trouble is the export restrictions that China has placed on raw materials. This has prompted US and European complaints to the WTO. Japanese companies are also complaining that China's stimulus hasn't resulted in stronger sales.

I think that at the risk of higher interest rates and oil, the Fed will talk a weak dollar tomorrow. We'll see. Also the unrest in Iran should be good for oil prices. Not sure enough to bet on it though.

Time to Buy Oil and Gold and Sell Stocks

Bloomberg reports that the Fed will talk down the dollar again. Whew! That was quick. They're still much more afraid of deflation than inflation. There are a bunch of ways to play this. First, there's Treasuries. Sounds like they might be going down again. On the other hand, if stocks go down, there may be some flight to quality, so I should be patient and cautious here. Next, there's oil. If they keep devaluing the dollar, oil will go up. However, I need to watch out for the supply situation, as well as the fact that if oil goes up enough to harm the economy, the Fed will have to pay attention to it and push it back down. If the Fed talks up the dollar, that will hurt stocks. If the Fed lets oil go higher, that hurts stocks as well. I think stocks are about to go down. How to play this? S&P 500 shorts? Maybe short SSO, the S&P 500 ultralong. Already got a lot of shorts, though. I think more gold is the only thing I'm going to do now.

Buy 86 (13%) ABX @ $33.00.

Patience

Patience

I think that the economy remains deep in a credit contraction, except for Fed activity.

As the "adverse" scenario for the bank stress-tests shows, they need $599 billion if unemployment averages 10.3% in 2010. It appears that this number might be optimistic.

At the same time, we have inflationary blowback from oil and mortgage rates killing any recovery.

But Bernanke only knows how to do one thing: print money. Private debt will default or be converted to public debt, and public debt will be inflated away.

In the meantime, the inflation trade has had a good 3-4 month run and is now running out of steam as it starts becoming self-defeating. So I need to bet against inflation here. What's this trade? Oil down, stocks down, bonds back up a bit, dollar up. Right now, I have 30% in gold, which I like. I have 30-40% in stock shorts, and 30% in Euro shorts.

Unfortunately, I sold my TBT too soon. It's now pushing $60. I would like to go back in when it drops back down to the 50-day moving average. Another negative for Treasuries is that China's exports just hit a record plunge of 26% yesterday, which means that they're going to be buying fewer Treasuries.

Well, probably the safest thing to do is wait for TBT, and oil to fall back to their 50-day moving averages and then decide if they're headed back down or the inflation trade is finally here to stay.

Dollar Devaluation Backfired - Or Does It?

I am now convinced that Bernanke's attempt to devalue the dollar out of depression has failed. He will not be able to do it. This article from Bloomberg says it all. The reason to devalue the dollar is to close the trade deficit and stop money from leaving the country. However, due to the increase in oil and a large drop in exports, this strategy has backfired. Mortgage rates have also continued their rise.

So, what's the strategy for this insight? Probably some combination of long dollar/short other currency, short oil, long Treasuries (maybe), and short equities (especially stocks reliant on consumer spending with high input costs).

On the other hand, we could use perverse logic to argue that Bernanke will think he hasn't devalued the dollar enough to drive up exports and decrease imports. Which is it?

Using the perverse logic, we would expect oil to continue higher, although it may be bearish for stocks.

In order to determine which one is more likely, let's do a thought experiment to see which, if any of these options, is a self-defeating or self-reinforcing process.

In the first scenario, dollar devaluation stops due to the side effect of rising rates and a stop in money printing. The dollar strengthens and oil drops. The fall in oil would then give Bernanke room to further devalue the dollar if the economy stayed weak.

In the second, Bernanke prints more money. Treasury rates increase, further killing the economy. So, Bernanke prints more money.

It all depends on Bernanke. If I use a "watch what he does, not what he says" rule, I'd predict more printing. However, I cannot be sure about that. I'm going to think about this more. However, there seems to be a nice long trend of money printing and dollar devaluation. I don't have enough info to do anything now, except be a little more confident in my equity shorts.

Craziness

So, apparently the futures market is pricing in a 66% chance of a 0.50% rate hike by the Fed later this year. Really? Are you kidding me? No, really? This shows a real recovery without inflationary side effects poisoning the green shoots (I think).

Here's what I'm sure about:

1. The job market is terrible. The ADP employment report is much more accurate than the BS (not a typo) stats that get the headlines. The unemployment rate will be over 10% in the next two months.
2. The consumer is (and will remain) much more interested in saving than spending.
   

So, if the market is pricing in a rate hike, are 30-yr. Treasuries pricing in as much inflation as they can? I think so. Time to sell TBT.

Sell TBT @ $57.11, +13%.

Confusion

Equities along with oil have resumed their upward surge. I believe now that the best explanation for what's happening in the stock and bond markets is a combination of bounceback from oversold sentiment and dollar devaluation.

VLCC crude carriers were currently going for $5,900 yesterday, according to Intertanko. That's lower than its been in years, and this tells me that demand is not driving the price of oil. So, what is then? It's not lower supply; OPEC hasn't cut production recently, and oil in storage is at multi-decade highs. That leaves the most likely explanation to be a fear of dollar devaluation, causing a flight out of Treasuries and into commodities and equities.

The consumer remains on life support. The savings rate jumped from 4.5% to 5.7% for the month of May. Consumer spending was down 4.6% (the Goldman Sach's measure of same store sales, ex Wal-Mart). Abercrombie and Fitch's (ANF) same-store sales were down 28%. Ouch! That's what happens to companies that don't slash prices.

Bonds are falling again. The ten-year is pushing back up towards 3.70%, and the 30-yr is back over 4.50% to 4.55%. And, of course, mortgage rates have jumped from 4.91% to 5.29%, according to Freddie Mac.

So, now that everyone knows that inflation is here, is it time to cut back on these positions? All the gurus have been out there explaining what's been happening. Now that this knowledge is out there, it's probably time to take some more stuff off the table. Maybe I'll cash in NG. I'd love to short oil here on the fundamentals of supply and demand, but the dollar devaluation story is very convincing to me here. Let's see what the charts show me. I'll look at DIG, DUG, and USO. DUG is 25% below the 50-day moving average. Looks low to me. DUG is 16% over the 50-day avg. DIG is still ineligible to short. Seems there's a lot of speculation that oil's going back down. USO shows a clear bullish chart. There could be a breakdown soon, but it looks like the longer trend is up.