Date: 09/12/2021
Author: Kent Moors, Ph.D.
For the past month, I have been advising Sigma Trader and PRISM Profits subscribers about how I track the advancing market contraction.
It involves my Σ Algorithm trading system calculations tracking four distinct indicators: (1) crude oil prices; (2) interest rates; (3) bitcoin/crypto currency reserves, and (4) ETF/ETN flow rates. I have called these my “four horsemen,” signals of an impending market slide. I have also noted on several occasions that these yardsticks assess underlying market currents, rather than the performance of any particular market segment or sector.
As we approached the end of last week (as I noted in the Portfolio Reviews sent out to subscribers), these four factors were synchronizing. Despite the continuing volatility in the market and the ongoing yo-yoing resulting, a common direction is forming.
As I write this, futures are showing another shallowness following the weakening close last Friday. I observed in Friday’s Portfolio Reviews that there are some elements combining to offset partially a stronger move down – a curious play designed to short leveraged bear funds (those that pay multiples of the decline in underlying stocks), with the funds shorted usually signaling a consolidation is developing; a late week dive in crypto currency valuations that has not translated into a decline in the coins serving as a reserve against market activity; another round of meme share buys in stocks that have been heavily shorted in the past (where, once again, the object is a Ponzi scheme approach that is not directed at the fundamentals of the targets but another attempt to punish other investors); and a hollow bounce back in crude oil prices reflecting a post-hurricane environment rather than any rise in energy demand.
Each of these is more properly an outlier rather than an indicator. In each case, either the intent or the short-term read says little about the genuine market elements. A bit of smoke and mirrors combined with some marginally quick profit scraping.
But the overall trajectory continues to be a weakening.
Of my four horsemen, crude oil prices are the focus of this Classified Intelligence Brief. Oil is again moving in a narrow range, effected by supply considerations following several hurricanes hitting the Gulf of Mexico. The two primary benchmark values drifted marginally lower for the week. West Texas Intermediate (WTI), the standard in New York, shed 0.66 percent, while Brent, the more often used global yardstick set daily in London, lost 0.67 percent. At 4.37 percent, the spread between the two as seen by the difference as a percentage of WTI (the more accurate way of measuring it), indicates that the current pricing remains stagnant.
As the volatility over the past several weeks attests, there is no map for this new environment. While traditional notions of supply and demand remain the knee jerk reaction to gyrating prices, the truth is nobody has a clear read on where the market is going in the very near term.
This is where we need to distinguish what is supportable in this market versus what talking heads are spouting on TV. The concern now is continuing high surplus oil supply levels, especially in the U.S. but also emerging elsewhere in the world, as the continuing COVID-19 pressure on worldwide economic performance combines with sagging energy demand levels.
The Paris-based International Energy Agency (IEA) is projecting a more prolonged oil glut than initially forecast, with a resulting pressure to limit price increases. However, this is based upon two factors that will not continue: production levels remaining where they are and a lack of storage capacity for the excess production.
Don’t misunderstand me here. I am not suggesting that we are moving into an appreciably changing pricing environment. WTI should still remain at about $70-72 a barrel on average into late fourth quarter with Brent about $3-4 above that, assuming there are no new geopolitical problems emerging by that time (which would spike the price higher).
Remember as well that a very high price for oil is no longer necessary to generate some nice returns on retail stock investments. The oil/natural gas sector is entering a very competitive situation. As the Mergers & Acquisitions (M&A) cycle heats up through the remainder of the year, that competition will take on a changing dimension and provide a number of profitable opportunities in new moves combined with some excellent existing niche plays.
And natural gas prices will accelerate higher than oil from now through at least early first quarter 2022.
However, as M&A kicks in, smaller, highly leveraged companies are becoming the targets of other American operating companies seeking to buttress book reserves by acquiring at discount to market rates.
The combination of a potentially massive global supply glut, augmented by the OPEC+ decision to allow additional exports while some producers add still more in various under the table deals, coupled with energetic M&A, is bringing us into virgin territory. Estimating target prices to affect the reduction in production while at the same time laying out the objects of acquisition is simply unique in my 40 plus years in the business. The IEA projection and some of the amateur reads on what it says quite miss the obvious. They are based on extrapolating rates today into the future.
But an accelerating pullback has already begun.
The buildup of production in the U.S. shale patch has been fueled by high-risk debt and unexpectedly excessive extraction rates. While the rig count continues slowly to move up, forward capital expenditure plans across the board have been impacted by several years of reduced commitments. That means primary domestic production will be coming from existing American wells.
It is here that the surfeit is prompting the misgivings. Storage capacity is disappearing. However, from the standpoint of the producer, there is quite a different picture.
Well over 80 percent of expenses are frontloaded in an oil project. That means the vast majority of investment has taken place before anything comes out of the ground. It is in the interest of the operator to continue production even if the wellhead price (the discounted amount a producer receives from the first arms-length sale to a wholesaler) is declining. The longer the well produces the more after-expense revenue is realized.
There are two factors to remember. First, unconventional (shale and tight oil) wells on average have a primary production life of about 18 months. With the current age of these wells, a declining production curve will hit in some cases before the end of this year and be met with an already drastic cut in future drilling plans.
The IEA extrapolation of a languid 2021 prices rise is predicated upon the drawdown in stored production combined with a declining forward production picture and continued existing volume.
Short-term, that is not the picture emerging.
And that finally brings me to today’s conclusion. Those traders who make their living betting on the future price of oil have introduced an interesting hedging strategy. While some new shorts are emerging (indicating a near term downward pressure in prices), the entire market is still moving into long positions – a calculation that prices are stagnating to slightly improving. This is supported by a futures contract contango situation. That means the contract price is higher as we move further into the future. While that might look good on paper, it primarily results in subdued prices closer on the pricing curve.
Bottom line: keep your power dry. There will be plenty of nice moves coming. But there will be no breakthrough coming anytime soon. A crude oil price rise to provide resistance to a market contraction is not going to emerge on the horizon anytime soon.
Dr. Kent Moors
This is an installment of Classified Intelligence Brief, your guide to what’s really happening behind the headlines… and how to profit from it. Dr. Kent Moors served the United States for 30 years as one of the most highly decorated intelligence operatives alive today (including THREE Presidential commendations).
After moving through the inner circles of royalty, oligarchs, billionaires, and the uber-rich, he discovered some of the most important secrets regarding finance, geo-politics, and business. As a result, he built one of the most impressive rolodexes in the world. His insights and network of contacts took him from a Vietnam veteran to becoming one of the globe’s most sought after consultants, with clients including six of the largest energy companies and the United States government.
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