Obviously, many in the financial news media are clueless and deserve a lump of coal in their stockings for the gloomy attitude that all too often permeates their reports. This was further reinforced on Wednesday when the Commerce Department reported that October retail sales rose 0.2%, in-line with economists estimates and a sign that consumer spending is not in the tailspin that the financial media is forecasting. As a result, I predict that the financial news media is going to be shocked by the tremendous shopping that begins on the Friday after Thanksgiving!
Last Thursday, the Labor Department reported that the Consumer Price Index (CPI) rose 0.3% (a 3.6% annual rate) in October, which was in line with economists' expectations. The core CPI, excluding food and energy, rose just 0.159% (a 1.9% annual rate), which was also in-line with economists' expectations. Higher food and energy prices contributed heavily to the increase in the overall CPI, rising 0.3% and 1.4%, respectively. The best news in the October CPI was that housing costs rose just 0.2%, so the housing crunch appears to be keeping overall inflation low.
By contrast, food and energy increases were lower in the Producer Price Index (PPI), which rose just 0.1% in October (a 1.2% annual rate), while wholesale energy prices fell 0.8%! As a result, the core rate of wholesale inflation, excluding food and energy, was unchanged. Economists had expected a 0.1% increase in both the overall PPI and core PPI, so the fact that the core PPI was unchanged was very bullish and provides the Fed additional room to cut key interest rates.
Despite these positive October reports, economists believe that inflation is still brewing in the pipeline. Some economists now expect a whopping 2% increase in the November PPI. This may explain why Wall Street largely ignored October's positive PPI report. But I feel there is a problem with their perma-bear outlook. Oil prices are suddenly falling! Apparently, economists are now figuring this out: As oil prices rise, demand can drop. For example, last week the International Energy Agency (IEA), the industrialized world's energy watchdog, lowered its prediction for global demand growth for the fourth quarter, which helped to ease fears of a short-term supply crunch. Additionally, some officials at the Organization of Petroleum Exporting Countries (OPEC), especially Saudi Arabia, said that they may consider raising their production ceiling as soon as next month. Clearly, the world is not about to run out of oil any time soon.
To prove my point, Saudi Arabia's oil minister, Ali Naimi, the de facto leader of OPEC, argued strenuously against what he called "the pessimists," who have driven up prices by predicting supply shortages and skyrocketing demand in emerging markets. Specifically, Ali Naimi told reporters last week that "The oil price today is no reflection whatsoever of the fundamentals" of supply and demand. Clearly such statements have a political tilt, since Saudi Arabian officials are eager to deflect the notion that they bear the blame for higher oil prices. Oil producers have stressed other factors, such as the falling U.S. dollar, geopolitical jitters (e.g., Iran and Pakistan) and especially market speculation and oil hoarding by some of those speculators.
This last point is evident by reports from Wall Street traders who had sold options to investors, including hedge funds, to buy oil at $100 a barrel, according to a Lehman Brothers report. Apparently, many hedge funds were betting that crude oil would top $100 and they could realize a quick profit by exercising their options. However, as too many hedge funds learned this summer, if they are all doing the same trade at once, it won't work. Ironically, Lehman Brothers reported that the closer oil crept to $100 per barrel, the more investment banks had been buying oil to hedge the risk of losses on the contracts, and so it appears that market speculation has been largely responsible for crude oil's recent surge, and fall. In fact, nearly a third of all options to buy crude at $100 on the New York Mercantile Exchange expired on Thursday and are now worthless. As a result of the expiration of these options, suddenly Wall Street firms did not have to buy oil as a hedge, so crude oil prices suddenly softened when oil speculation moderated.
Let's turn from speculation back to supply and demand. The IEA's monthly report suggested the world's oil supply-demand balance may be softer than initially forecast. Specifically, the IEA said it was lowering its prediction for global demand growth for the fourth quarter by 500,000 barrels a day, due mainly to signs of weakening demand in the U.S. and the countries of the former Soviet Union. The IEA added that world oil supply rose in October by 1.4 million barrels a day. One surprise performer was Iraq, where output from its northern fields is expected to top 600,000 barrels a day this month, the highest level since 2003, when the U.S. entered Iraq.
The IEA also noted increased production from Angola, a new OPEC member, now emerging as an important supplier of crude to the U.S. And last week, I reported to you about Brazil's huge (eventually supplying 200,000 barrels a day) new offshore discovery. Overall, OPEC countries supply around 40% of the world's oil demand, which now runs at just over 85 million barrels a day. Demand for oil has continued to climb in the developing world, but it has actually fallen in some Europe countries and has barely increased in the U.S. As a result, the IEA says "strong indications are now emerging that high prices are depressing demand" in industrialized countries.
The other good news regarding the supply and demand situation is that last week, Russia's energy minister, Viktor Khristenko, stated that the Russian government is considering new tax breaks to stimulate investment and boost production. Russia is the world's second largest oil exporter after Saudi Arabia and is striving to boost its production to 10.4 million barrels a day, compared with 9.8 million barrels a day now. The country's new oil production will likely come from developing projects in Eastern Siberia, offshore Sakhalin Island and the Arctic north projects. The only stumbling block is that Russian leaders stole a controlling interest in its most successful fields and may have alienated major foreign oil companies. However, now that Russia needs major capital investments to explore vast areas in the Arctic and Western Siberia, it will meekly invite the big oil companies back in, with tax breaks and better guarantees for their property rights.
