The price of oil collapsed by more than 8 percent on Wednesday, and a decision by the European Central Bank has Greece at the precipice of a complete and total financial meltdown. What a difference 24 hours can make. On Tuesday, things really seemed like they were actually starting to get better. The price of oil had rallied by more than 20 percent since last Thursday, things in Europe seemed like they were settling down, and there appeared to be a good deal of optimism about how global financial markets would perform this month. But now fear is back in a big way. Of course nobody should get too caught up in how the markets behave on any single day. The key is to take a longer term point of view. And the fact that the markets have been on such a roller coaster ride over the past few months is a really, really bad sign. When things are calm, markets tend to steadily go up. But when the waters start really getting choppy, that is usually a sign that a big move down in on the horizon. So the huge ups and the huge downs that we have witnessed in recent days are likely an indicator that rough seas are ahead.
A stunning decision that the European Central Bank has just made has set the stage for a major showdown in Europe. The ECB has decided that it will no longer accept Greek government bonds as collateral from Greek banks. This gives the European Union a tremendous amount of leverage in negotiations with the new Greek government. But in the short-term, this could mean some significant pain for the Greek financial system. The following is how a CNBC article described what just happened…
“The European Central Bank is telling the Greek banking system that it will no longer accept Greek bonds as collateral for any repurchase agreement the Greek banks want to conduct,” said Peter Boockvar, chief market analyst at The Lindsey Group, said in a note.
“This is because the ECB only accepts investment grade paper and up until today gave Greece a waiver to this clause. That waiver has now been taken away and Greek banks now have to go to the Greek Central Bank and tap their Emergency Liquidity Assistance facility for funding,” he said.
And it certainly didn’t take long for global financial markets to respond to this news…
The Greek stock market closed hours ago, but the exchange-traded fund that tracks Greek stocks, GREK, crashed during the final minutes of trading in the US markets.
The euro is also getting walloped, falling 1.3% against the US dollar.
The EUR/USD, which had recovered to almost 1.15, fell to nearly 1.13 on news of the action taken by the ECB.
But this is just the beginning.
In coming months, I fully expect the euro to head toward parity with the U.S. dollar.
And if the new Greek government will not submit to the demands of the EU, and Greece ultimately ends up leaving the common currency, it could potentially mean the end of the eurozone in the configuration that we see it today.
Meanwhile, the oil crash has taken a dangerous new turn.
Over the past week, we have seen the price of oil go from $43.58 to $54.24 to less than 48 dollars before rebounding just a bit at the end of the day on Wednesday.
This kind of erratic behavior is the exact opposite of what a healthy market would look like.
What we really need is a slow, steady climb which would take the price of oil back to at least the $80 level. In the current range in which it has been fluctuating, the price of oil is going to be absolutely catastrophic for the global economy, and the longer it stays in this current range the more damage that it is going to do.
But of course the problems that we are facing are not just limited to the oil price crash and the crisis in Greece. The truth is that there are birth pangs of the next great financial collapse all over the place. We just have to be honest with ourselves and realize what all of these signs are telling us.
And it isn’t just in the western world where people are sounding the alarm. All over the world, highly educated professionals are warning that a great storm is on the horizon. The other day, I had an economist in Germany write to me with his concerns. And in China, the head of the Dagong Rating Agency is declaring that we are going to have to face “a new world financial crisis in the next few years”…
The world economy may slip into a new global financial crisis in the next few years, China’s Dagong Rating Agency Head Guan Jianzhong said in an interview with TASS news agency on Wednesday.
“I believe we’ll have to face a new world financial crisis in the next few years. It is difficult to give the exact time but all the signs are present, such as the growing volume of debts and the unsteady development of the economies of the US, the EU, China and some other developing countries,” he said, adding the situation is even worse than ahead of 2008.
For a long time, I have been pointing at the year 2015. But this year is not going to be the end of anything. Rather, it is just going to be the beginning of the end.
During the past few years, we have experienced a temporary bubble of false stability fueled by reckless money printing and an unprecedented accumulation of debt. But instead of fixing anything, those measures have just made the eventual crash even worse.
Now a day of reckoning is fast approaching.
Life as we know it is about to change dramatically, and most people are completely and totally unprepared for it.
We are really starting to see the price of oil weigh very heavily on the economy and on the stock market. On Tuesday, the Dow was down 291 points, and the primary reason for the decline was disappointing corporate sales numbers. For example, heavy equipment manufacturer Caterpillar is blaming the “dramatic decline in the price of oil” for much lower than anticipated sales during the fourth quarter of 2014. Even though Caterpillar is not an “energy company”, the price of oil is critical to their success. And the same could be said about thousands of other companies. That is why I have repeatedly stated that anyone who believes that collapsing oil prices are good for the U.S. economy is crazy. The key to how much damage this oil collapse is going to do to our economy is not how low prices ultimately go. Rather, the key is how long they stay at these low levels. If the price of oil went back to $80 a barrel next week, the damage would be fairly minimal. But if the price of oil stays at this current level for the remainder of 2015, the damage will be absolutely catastrophic. Just think of the price of oil like a hot iron. If you touch it for just a fraction of a second, it won’t do too much damage. But if you press it against your skin for an hour, you will be severely damaged for the rest of your life at the very least.
So the damage that we are witnessing right now is just the very beginning unless the price of oil goes back up substantially.
When the price of oil first started crashing, most analysts focused on the impact that it would have on energy companies. And without a doubt, quite a few of them are likely to be wiped out if things don’t change soon.
But of even greater importance is the ripple effects that the price of oil will have throughout our entire economy. The oil price crash is not that many months old at this point, and yet big companies are already blaming it for causing significant problems. The following is how Caterpillar explained their disappointing sales numbers on Tuesday…
“The recent dramatic decline in the price of oil is the most significant reason for the year-over-year decline in our sales and revenues outlook. Current oil prices are a significant headwind for Energy & Transportation and negative for our construction business in the oil producing regions of the world. In addition, with lower prices for copper, coal and iron ore, we’ve reduced our expectations for sales of mining equipment. We’ve also lowered our expectations for construction equipment sales in China. While our market position in China has improved, 2015 expectations for the construction industry in China are lower”
We also learned on Tuesday that orders for durable goods were extremely disappointing. Many analysts believe that this is another area where the oil price crash is having an impact…
Orders for business equipment unexpectedly fell in December for a fourth month, signaling a global growth slowdown is weighing on American companies. Bookings for non-military capital goods excluding aircraft dropped 0.6 percent for a second month, data from the Commerce Department showed. Demand for all durable goods − items meant to last at least three years − declined 3.4 percent, the worst performance since August.
Let’s keep an eye on the durable goods numbers in coming months. Usually, when the economy is heading into a recession durable goods numbers start declining.
Meanwhile, a bunch of other big companies reported disappointing sales numbers on Tuesday as well. The following summary comes from the Crux…
Microsoft lost 9.9 percent as software-license sales to businesses were below forecasts. Caterpillar plunged 7.3 percent after forecasting 2015 results that trailed estimates as plunging oil prices signal lower demand from energy companies. DuPont Co. dropped 2.8 percent as a stronger dollar cuts into the chemical maker’s profit. Procter & Gamble Co. and United Technologies Corp. declined at least 2 percent after saying the surging greenback will lower full-year earnings.
What the economy could really use right now is a huge rebound in the price of oil.
Unfortunately, as I wrote about the other day, that is not likely to happen any time soon.
In fact, a top executive for Goldman Sachs recently told CNBC that he believes that the price of oil could ultimately go as low as 30 dollars a barrel.
And hedge fund managers are backing up their belief that oil is heading even lower with big money…
Hedge funds boosted bearish wagers on oil to a four-year high as US supplies grew the most since 2001.
Money managers increased short positions in West Texas Intermediate crude to the highest level since September 2010 in the week ended January 20, US Commodity Futures Trading Commission data show. Net-long positions slipped for the first time in three weeks.
US crude supplies rose by 10.1 million barrels to 397.9 million in the week ended January 16 and the country will pump the most oil since 1972 this year, the Energy Information Administration says. Saudi Arabia’s King Salman, the new ruler of the world’s biggest oil exporter, said he will maintain the production policy of his predecessor despite a 58 percent drop in prices since June.
Sadly, the truth is that anyone that thought that the stock market would go up forever and that the U.S. economy would be able to avoid a major downturn indefinitely was just being delusional.
Our economy goes through cycles, and every financial bubble eventually bursts.
For example, did you know that the S&P 500 has never had seven up years in a row? The following comes from a CNBC article that was posted on Tuesday…
Doubleline Capital founder Jeff Gundlach, more known for his bond prowess than as an equity market expert, pointed out that the S&P 500 has never had seven consecutive up years.
Of course, records are made to be broken, and each year is supposed to stand on its own.
But in a market that faces an uncertain future regarding monetary policy, the specter of a global economic slowdown, and an oil price plunge that is dampening capital investment, Gundlach’s little factoid sparked a lot of chatter at ETF.com’s InsideETFs conference in Hollywood, Florida.
Hmm – that reminds me of the seven year cycles that I discussed in my article yesterday.
If the price of oil stays this low for the rest of 2015, there is no way that we are going to avoid a recession.
If the price of oil stays this low for the rest of 2015, there is no way that we are going to avoid a stock market crash.
So let’s hope that the price of oil starts going back up.
If it doesn’t, the damage that is inflicted on our economy is going to get progressively worse.
The gravy train is over for oil workers. All over North America, people that felt very secure about their jobs just a few weeks ago are now getting pink slips. There are even some people that I know personally that this has happened to. The economy is really starting to bleed oil patch jobs, and as long as the price of oil stays down at this level the job losses are going to continue. But this is what happens when a “boom” turns into a “bust”. Since 2003, drilling and extraction jobs in the United States have doubled. And these jobs typically pay very well. It is not uncommon for oil patch workers to make well over $100,000 a year, and these are precisely the types of jobs that we cannot afford to be losing. The middle class is struggling mightily as it is. And just like we witnessed in 2008, oil industry layoffs usually come before a downturn in employment for the overall economy. So if you think that it is tough to find a good job in America right now, you definitely will not like what comes next.
At one time, I encouraged those that were desperate for employment to check out states like North Dakota and Texas that were experiencing an oil boom. Unfortunately, the tremendous expansion that we witnessed is now reversing…
In states like North Dakota, Oklahoma and Texas, which have reaped the benefits of a domestic oil boom, the retrenchment is beginning.
“Drilling budgets are being slashed across the board,” said Ron Ness, president of the North Dakota Petroleum Council, which represents more than 500 companies working in the state’s Bakken oil patch.
Smaller budgets and less extraction activity means less jobs.
Often, the loss of a job in this industry can come without any warning whatsoever. Just check out the following example from a recent Bloomberg article…
The first thing oilfield geophysicist Emmanuel Osakwe noticed when he arrived back at work before 8 a.m. last month after a short vacation was all the darkened offices.
By that time of morning, the West Houston building of his oilfield services company was usually bustling with workers. A couple hours later, after a surprise call from Human Resources, Osakwe was adding to the emptiness: one of thousands of energy industry workers getting their pink slips as crude prices have plunged to less than $50 a barrel.
These jobs are not easy to replace. If oil industry veterans go down to the local Wal-Mart to get jobs, they will end up making only a very small fraction of what they once did. Every one of these jobs that gets lost is really going to hurt.
And at this point, the job losses in the oil industry are threatening to become an avalanche. The following are 12 signs that the economy is really starting to bleed oil patch jobs…
#1 It is being projected that the U.S. oil rig count will decline by 15 percent in the first quarter of 2015 alone. And when there are less rigs operating, less workers are needed so people get fired.
#2 Last week, 55 more oil rigs shut down. That was the largest single week decline in the United States in 24 years.
#3 Oilfield services provider Baker Hughes has announced that it plans to lay off 7,000 workers.
#4 Schlumberger, a big player in the energy industry, has announced plans to get rid of 9,000 workers.
#5 Suncor Energy is eliminating 1,000 workers from their oil projects up in Canada.
#6 Halliburton’s energy industry operations have slowed down dramatically, so they gave pink slips to 1,000 workers last month.
#7 Diamondback Energy just slashed their capital expenditure budget 40 percent to just $450 million.
#8 Elevation Resources plans to cut their capital expenditure budget from $227 million to $100 million.
#9 Concho Resources says that it plans to reduce the number of rigs that it is operating from 35 to 25.
#10 Tullow Oil has reduced their exploration budget from approximately a billion dollars to about 200 million dollars.
#11 Henry Resources President Danny Campbell has announced that his company is reducing activity “by up to 40 percent“.
#12 The Federal Reserve Bank of Dallas is projecting that 140,000 jobs related to the energy industry will be lost in the state of Texas alone during 2015.
And of course it isn’t just workers that are going to suffer.
Some states are extremely dependent on oil revenues. Just take the state of Alaska for instance. According to one recent news report, 90 percent of the budget of Alaska comes from oil revenue…
But oil is also a revenue source in more than two dozen states, especially for about a third of them. In Alaska, where up to 90 percent of the budget is funded by oil, new Gov. Bill Walker has ordered agency heads to start identifying spending cuts.
Sadly, it looks like oil is not going to rebound any time soon.
China, the biggest user of oil in the world, just reported that economic growth expanded at the slowest pace in 24 years. And concerns about oversupply drove the price of U.S. crude down another couple of dollars on Monday…
Oil declined about 5 percent on Tuesday after the International Monetary Fund cut its 2015 global economic forecast on lower fuel demand and key producer Iran hinted prices could drop to $25 a barrel without supportive OPEC action.
U.S. crude, also known as West Texas Intermediate or WTI, settled 4.7 percent lower at $46.39 a barrel, near its intraday bottom of $46.23.
There is only one other time in history when we have seen an oil price crash of this magnitude.
That was in 2008, just before the greatest financial crisis since the Great Depression.
Many believe that we are now on the verge of the next great financial crisis.
I hope that you are getting ready.
If you were waiting for a “black swan event” to come along and devastate the global economy, you don’t have to wait any longer. As I write this, the price of U.S. oil is sitting at $45.76 a barrel. It has fallen by more than 60 dollars a barrel since June. There is only one other time in history when we have seen anything like this happen before. That was in 2008, just prior to the worst financial crisis since the Great Depression. But following the financial crisis of 2008, the price of oil rebounded fairly rapidly. As you will see below, there are very strong reasons to believe that it will not happen this time. And the longer the price of oil stays this low, the worse our problems are going to get. At a price of less than $50 a barrel, it is just a matter of time before we see a huge wave of energy company bankruptcies, massive job losses, a junk bond crash followed by a stock market crash, and a crisis in commodity derivatives unlike anything that we have ever seen before. So let’s hope that a very unlikely miracle happens and the price of oil rebounds substantially in the months ahead. Because if not, the price of oil is going to absolutely rip the global economy to shreds.
What amazes me is that there are still many economic “experts” in the mainstream media that are proclaiming that the collapse in the price of oil is going to be a good thing for the U.S. economy.
The only precedent that we can compare the current crash to is the oil price collapse of 2008. You can see both crashes on the chart below…
If rapidly falling oil prices are good economic news, that collapse should have pushed the U.S. economy into overdrive.
But that didn’t happen, did it? Instead, we plunged into the deepest recession that we have seen since the Great Depression.
And unless there is a miracle rebound in the price of oil now, we are going to experience something similar this time.
Already, we are seeing oil rigs shut down at a staggering pace. The following is from Bloomberg…
U.S. oil drillers laid down the most rigs in the fourth quarter since 2009. And things are about to get much worse.
The rig count fell by 93 in the three months through Dec. 26, and lost another 17 last week, Baker Hughes Inc. data show. About 200 more will be idled over the next quarter as U.S. oil explorers make good on their promises to curb spending, according to Moody’s Corp.
But that was just the beginning of the carnage. 61 more oil rigs shut down last week alone, and hundreds more are being projected to shut down in the months ahead.
For those that cannot connect the dots, that is going to translate into the loss of large numbers of good paying jobs. Just check out what is happening in Texas…
A few days ago, Helmerich & Payne, announced that it would idle 50 more drilling rigs in February, after having already idled 11 rigs. Each rig accounts for about 100 jobs. This will cut its shale drilling activities by 20%. The other two large drillers, Nabors Industries and Patterson-UTI Energy are on a similar program. All three combined are “likely to cut approximately 15,000 jobs out of the 50,000 people they currently employ,” said Oilpro Managing Director Joseph Triepke.
Unfortunately, this crisis will not just be localized to states such as Texas. There are tens of thousands of small and mid-size firms that will be affected. The following is from a recent CNBC report…
More than 20,000 small and midsize firms drive the “hydrocarbon revolution” in the U.S. that has helped the oil and gas industry thrive in recent years, and they produce more than 75 percent of the nation’s oil and gas output, according to the Manhattan Institute for Policy Research’s February 2014 Power & Growth Initiative Report. The Manhattan Institute is a conservative think tank in New York City.
A sustained decline in prices could lead to layoffs at these firms, say experts. “The energy industry has been one of the job-growth areas leading us out of the recession,” said Chad Mabry, a Houston-based analyst in the energy and natural resources research department of boutique investment bank MLV & Co. in New York City. “In 2015, that changes in this price environment,” he said. “We’re probably going to see some job losses on a fairy significant scale if this keeps up.”
If the price of oil makes a major comeback, the carnage will ultimately not be that bad.
But if it stays at this level or keeps going down for an extended period of time, it is inevitable that a whole bunch of those firms will go bankrupt and their debt will go bad.
That would mean a junk bond crash unlike anything that Wall Street has ever experienced.
And as I have written about previously, a stock market crash almost always follows a junk bond crash.
These are things that happened during the last financial crisis and that are repeating again right in front of our eyes.
Another thing that happened in 2008 that is happening again is a crash in industrial commodity prices.
At this point, industrial commodity prices have hit a 12 year low. I am talking about industrial commodities such as copper, iron ore, steel and aluminum. This is a huge sign that global economic activity is slowing down and that big trouble is on the way.
So what is driving this? The following excerpt from a recent Zero Hedge article gives us a clue…
Globally there are over $9 trillion worth of borrowed US Dollars in the financial system. When you borrow in US Dollars, you are effectively SHORTING the US Dollar.
Which means that when the US Dollar rallies, your returns implode regardless of where you invested the borrowed money (another currency, stocks, oil, infrastructure projects, derivatives).
Take a look at commodities. Globally, there are over $22 TRILLION worth of derivatives trades involving commodities. ALL of these were at risk of blowing up if the US Dollar rallied.
Unfortunately, starting in mid-2014, it did in a big way.
This move in the US Dollar imploded those derivatives trades. If you want an explanation for why commodities are crashing (aside from the fact the global economy is slowing) this is it.
Once again, much of this could be avoided if the price of oil starts going back up substantially.
Unfortunately, that does not appear likely. In fact, many of the big banks are projecting that it could go even lower…
Goldman Sachs, CitiGroup, Societe General and Commerzbank are among the latest investment banks to reduce crude oil price estimates, and without production cuts, there appears to be more room for lower prices.
“We’re going to keep on going lower,” says industry analyst Brian Milne of energy manager Schneider Electric. “Even with fresher new lows, there’s still more downside.”
OPEC could stabilize global oil prices with a single announcement, but so far OPEC has refused to do this. Many believe that the OPEC countries actually want the price of oil to fall for competitive reasons…
Representatives of Saudi Arabia, the United Arab Emirates and Kuwait stressed a dozen times in the past six weeks that the group won’t curb output to halt the biggest drop in crude since 2008. Qatar’s estimate for the global oversupply is among the biggest of any producing country. These countries actually want — and are achieving — further price declines as part of an attempt to hasten cutbacks by U.S. shale drillers, according to Barclays Plc and Commerzbank AG.
The oil producing countries in the Middle East seem to be settling in for the long haul. In fact, one prominent Saudi prince made headlines all over the world this week when he said that “I’m sure we’re never going to see $100 anymore.”
Never is a very strong word.
Could there be such a massive worldwide oil glut going on right now that the price of oil will never get that high again?
Well, without a doubt there is a huge amount of unsold oil floating around out there at the moment.
It has gotten so bad that some big trading companies are actually hiring supertankers to store large quantities of unsold crude oil at sea…
Some of the world’s largest oil traders have this week hired supertankers to store crude at sea, marking a milestone in the build-up of the global glut.
Trading firms including Vitol, Trafiguraand energy major Shell have all booked crude tankers for up to 12 months, freight brokers and shipping sources told Reuters.
They said the flurry of long-term bookings was unusual and suggested traders could use the vessels to store excess crude at sea until prices rebound, repeating a popular 2009 trading gambit when prices last crashed.
The fundamentals for the price of oil are so much worse than they were back in 2008.
We could potentially be looking at sub-$50 oil for an extended period of time.
If that is indeed the case, there will be catastrophic damage to the global economy and to the global financial system.
So hold on to your hats, because it looks like we are going to be in for quite a bumpy ride in 2015.
On Monday, the price of oil fell below $50 for the first time since April 2009, and the Dow dropped 331 points. Meanwhile, the stock market declines over in Europe were even larger on a percentage basis, and the euro sank to a fresh nine year low on concerns that the anti-austerity Syriza party will be victorious in the upcoming election in Greece. These are precisely the kinds of things that we would expect to see happen if a global financial crash was coming in 2015. Just prior to the financial crisis of 2008, the price of oil collapsed, prices for industrial commodities got crushed and the U.S. dollar soared relative to other currencies. All of those things are happening again. And yet somehow many analysts are still convinced that things will be different this time. And I agree that things will indeed be “different” this time. When this crisis fully erupts, it will make 2008 look like a Sunday picnic.
Another thing that usually happens when financial markets begin to unravel is that they get really choppy. There are big ups and big downs, and that is exactly what we have witnessed since October.
So don’t expect the markets just to go in one direction. In fact, it would not be a surprise if the Dow went up by 300 or 400 points tomorrow. During the initial stages of a financial crash, there are always certain days when the markets absolutely soar.
For example, did you know that the three largest single day stock market advances in history were right in the middle of the financial crash of 2008? Here are the dates and the amount the Dow rose each of those days…
October 13th, 2008: +936 points
October 28th, 2008: +889 points
November 13th, 2008: +552 points
Just looking at those three days, you would assume that the fall of 2008 was the greatest time ever for stocks. But instead, it was the worst financial crash that we have seen since the days of the Great Depression.
So don’t get fooled by the volatility. Choppy markets are almost always a sign of big trouble ahead. Calm waters usually mean that the markets are going up.
In order to avoid a major financial crisis in the near future, we desperately need the price of oil to rebound in a substantial way.
Unfortunately, it does not look like that is going to happen any time soon. There is just way too much oil being produced right now. The following is an excerpt from a recent CNBC article…
The Morgan Stanley strategists say there are new reports of unsold West and North African cargoes, with much of the oil moving into storage. They also note that new supply has entered the global market with additional exports coming from Russia and Iraq, which is reportedly seeing production rising to new highs.
Since June, the price of oil has plummeted close to 55 percent. If the price of oil stays where it is right now, we are going to see large numbers of small producers go out of business, the U.S. economy will lose millions of jobs, billions of dollars of junk bonds will go bad and trillions of dollars of derivatives will be in jeopardy.
And the lower the price of oil goes, the worse our problems are going to get. That is why it is so alarming that some analysts are now predicting that the price of oil could hit $40 later this month…
Some traders appeared certain that U.S. crude will hit the $40 region later in the week if weekly oil inventory numbers for the United States on Wednesday show another supply build.
‘We’re headed for a four-handle,’ said Tariq Zahir, managing member at Tyche Capital Advisors in Laurel Hollow in New York. ‘Maybe not today, but I’m sure when you get the inventory numbers that come out this week, we definitely will.’
Open interest for $40-$50 strike puts in U.S. crude have risen several fold since the start of December, while $20-$30 puts for June 2015 have traded, said Stephen Schork, editor of Pennsylvania-based The Schork Report.
The only way that the price of oil has a chance to move back up significantly is if global production slows down. But instead, production just continues to increase in the short-term thanks to projects that were already in the works. As a result, analysts from Morgan Stanley say that the oil glut is only going to intensify…
Morgan Stanley analysts said new production will continue to ramp up at a number of fields in Brazil, West Africa, Canada and in the U.S. Gulf of Mexico as well as U.S. shale production. Also, the potential framework agreement with Iran could mean more Iranian oil on the market.
Yes, lower oil prices mean that we get to pay less for gasoline when we fill up our vehicles.
But as I have written about previously, anyone that believes that lower oil prices are good for the U.S. economy or for the global economy as a whole is crazy. And these sentiments were echoed recently by Jeff Gundlach…
“Oil is incredibly important right now. If oil falls to around $40 a barrel then I think the yield on ten year treasury note is going to 1%. I hope it does not go to $40 because then something is very, very wrong with the world, not just the economy. The geopolitical consequences could be – to put it bluntly – terrifying.“
If the price of oil does not recover, we are going to see massive financial problems all over the planet and the geopolitical stress that this will create will be unbelievable.
To expand on this point, I want to share an excerpt from a recent Zero Hedge article. As you can see, a rapid rise or fall in the price of oil almost always correlates with a major global crisis of some sort…
Large and rapid rises and falls in the price of crude oil have correlated oddly strongly with major geopolitical and economic crisis across the globe. Whether driven by problems for oil exporters or oil importers, the ‘difference this time’ is that, thanks to central bank largesse, money flows faster than ever and everything is more tightly coupled with that flow.
So is the 45% YoY drop in oil prices about to ’cause’ contagion risk concerns for the world?
And without a doubt, we are overdue for another stock market crisis.
Between December 31st, 1996 and March 24th, 2000 the S&P 500 rose 106 percent.
Then the dotcom bubble burst and it fell by 49 percent.
Between October 9th, 2002 and October 9th, 2007 the S&P 500 rose 101 percent.
But then that bubble burst and it fell by 57 percent.
Between March 9th, 2009 and December 31st, 2014 the S&P 500 rose an astounding 204 percent.
When this bubble bursts, how far will it fall this time?
Who is to blame for the staggering collapse of the price of oil? Is it the Saudis? Is it the United States? Are Saudi Arabia and the U.S. government working together to hurt Russia? And if this oil war continues, how far will the price of oil end up falling in 2015? As you will see below, some analysts believe that it could ultimately go below 20 dollars a barrel. If we see anything even close to that, the U.S. economy could lose millions of good paying jobs, billions of dollars of energy bonds could default and we could see trillions of dollars of derivatives related to the energy industry implode. The global financial system is already extremely vulnerable, and purposely causing the price of oil to crash is one of the most deflationary things that you could possibly do. Whoever is behind this oil war is playing with fire, and by the end of this coming year the entire planet could be dealing with the consequences.
Ever since the price of oil started falling, people have been pointing fingers at the Saudis. And without a doubt, the Saudis have manipulated the price of oil before in order to achieve geopolitical goals. The following is an excerpt from a recent article by Andrew Topf…
We don’t have to look too far back in history to see Saudi Arabia, the world’s largest oil exporter and producer, using the oil price to achieve its foreign policy objectives. In 1973, Egyptian President Anwar Sadat convinced Saudi King Faisal to cut production and raise prices, then to go as far as embargoing oil exports, all with the goal of punishing the United States for supporting Israel against the Arab states. It worked. The “oil price shock” quadrupled prices.
It happened again in 1986, when Saudi Arabia-led OPEC allowed prices to drop precipitously, and then in 1990, when the Saudis sent prices plummeting as a way of taking out Russia, which was seen as a threat to their oil supremacy. In 1998, they succeeded. When the oil price was halved from $25 to $12, Russia defaulted on its debt.
The Saudis and other OPEC members have, of course, used the oil price for the obverse effect, that is, suppressing production to keep prices artificially high and member states swimming in “petrodollars”. In 2008, oil peaked at $147 a barrel.
Turning to the current price drop, the Saudis and OPEC have a vested interest in taking out higher-cost competitors, such as US shale oil producers, who will certainly be hurt by the lower price. Even before the price drop, the Saudis were selling their oil to China at a discount. OPEC’s refusal on Nov. 27 to cut production seemed like the baldest evidence yet that the oil price drop was really an oil price war between Saudi Arabia and the US.
If the Saudis wanted to stabilize the price of oil, they could do that immediately by announcing a production cutback.
The fact that they have chosen not to do this says volumes.
In addition to wanting to harm U.S. shale producers, some believe that the Saudis are determined to crush Iran. This next excerpt comes from a recent Daily Mail article…
Above all, Saudi Arabia and its Gulf allies see Iran — a bitter religious and political opponent — as their main regional adversary.
They know that Iran, dominated by the Shia Muslim sect, supports a resentful underclass of more than a million under-privileged and angry Shia people living in the gulf peninsula — a potential uprising waiting to happen against the Saudi regime.
The Saudis, who are overwhelmingly Sunni Muslims, also loathe the way Iran supports President Assad’s regime in Syria — with which the Iranians have a religious affiliation. They also know that Iran, its economy plagued by corruption and crippled by Western sanctions, desperately needs the oil price to rise. And they have no intention of helping out.
The fact is that the Saudis remain in a strong position because oil is cheap to produce there, and the country has such vast reserves. It can withstand a year — or three — of low oil prices.
There are others out there that are fully convinced that the Saudis and the U.S. are actually colluding to drive down the price of oil, and that their real goal is to destroy Russia.
In fact, Venezuela’s President Nicolas Maduro openly promoted this theory during a recent speech on Venezuelan national television…
“Did you know there’s an oil war? And the war has an objective: to destroy Russia,” he said in a speech to state businessmen carried live on state TV.
“It’s a strategically planned war … also aimed at Venezuela, to try and destroy our revolution and cause an economic collapse,” he added, accusing the United States of trying to flood the market with shale oil.
Venezuela and Russia, which both have fractious ties with Washington, are widely considered the nations hardest hit by the global oil price fall.
And as I discussed just the other day, Russian President Vladimir Putin seems to agree with this theory…
“We all see the lowering of oil prices. There’s lots of talk about what’s causing it. Could it be an agreement between the U.S. and Saudi Arabia to punish Iran and affect the economies of Russia and Venezuela? It could.”
Without a doubt, Obama wants to “punish” Russia for what has been going on in Ukraine. Going after oil is one of the best ways to do that. And if the U.S. shale industry gets hurt in the process, that is a bonus for the radical environmentalists in Obama’s administration.
There are yet others that see this oil war as being even more complicated.
Marin Katusa believes that this is actually a three-way war between OPEC, Russia and the United States…
“It’s a three-way oil war between OPEC, Russia and North American shale,” says Marin Katusa, author of “The Colder War,” and chief energy investment strategist at Casey Research.
Katusa doesn’t see production slowing in 2015: “We know that OPEC will not be cutting back production. They’re going to increase it. Russia has increased production to all-time highs.” With Russia and OPEC refusing to give up market share how will the shale industry compete?
Katusa thinks the longevity and staying power of the shale industry will keep it viable and profitable. “The versatility and the survivability of a lot of these shale producers will surprise people. I don’t see that the shale sector is going to collapse over night,” he says. Shale sweet spots like North Dakota’s Bakken region and Texas’ Eagle Ford area will help keep production levels up and output steady.
Whatever the true motivation for this oil war is, it does not appear that it is going to end any time soon.
And so that means that the price of oil is going to go lower.
How much lower?
One analyst recently told CNN that we could see the price of oil dip into the $30s next year…
Few saw the energy meltdown coming. Now that it’s here, industry analysts warn another move lower is possible as the momentum remains firmly to the downside.
“If this doesn’t hold, we could go back to price levels in late 2008 and early 2009 — down in the $30s. There’s no reason why it couldn’t happen,” said Darin Newsom, senior analyst at Telvent DTN.
Others are even more pessimistic. For instance, Jeremy Warner of the Sydney Morning Herald, who correctly predicted that the price of oil would fall below $80 this year, is now forecasting that the price of oil could fall all the way down to $20 next year…
Revisiting the past year’s predictions is, for most columnists a frequently humbling experience. The howlers tend to far outweigh the successes. Yet, for a change, I can genuinely claim to have got my main call for markets – that oil would sink to $US80 a barrel or less – spot on, and for the right reasons, too.
Just in case you think I’m making it up, this is what I said 12 months ago: “My big prediction is for $US80 oil, from which much of the rest of my outlook for the coming year flows. It’s hard to overstate the significance of a much lower oil price – Brent at, say, $US80 a barrel, or perhaps lower still – yet this is a surprisingly likely prospect, the implications of which have been largely missed by mainstream economic forecasters.”
If on to a good thing, you might as well stick with it; so for the coming year, I’m doubling up on this forecast. Far from bouncing back to the post crisis “normal” of something over $US100 a barrel, as many oil traders seem to expect, my view is that the oil price will remain low for a long time, sinking to perhaps as little as $US20 a barrel over the coming year before recovering a little.
But even Warner’s chilling prediction is not the most bearish.
A technical analyst named Abigail Doolittle recently told CNBC that under a worst case scenario the price of oil could fall as low as $14 a barrel…
No one really saw 2014’s dramatic plunge in oil price coming, so it’s probably fair to say that any predictions about where it’s going from here fall somewhere between educated guesses and picking a number out of a hat.
In that light, it’s less than shocking to see one analyst making a case—albeit in a pure outlier sense—for a drop all the way below $14 a barrel.
Abigail Doolittle, who does business under the name Peak Theories Research, posits that current chart trends point to the possibility that crude has three downside target areas where it could find support—$44, $35 and the nightmare scenario of, yes, $13.65.
But the truth is that none of those scenarios need to happen in order for this oil war to absolutely devastate the U.S. economy and the U.S. financial system.
There is a very strong correlation between the price of oil and the performance of energy stocks and energy bonds. But over the past couple of weeks this correlation has been broken. The following chart comes from Zero Hedge…
It is inevitable that at some point we will see energy stocks and energy bonds come back into line with the price of crude oil.
And it isn’t just energy stocks and bonds that we need to be concerned about. There is only one other time in all of history when the price of oil has crashed by more than 50 dollars in less than a year. That was in 2008 – just before the great financial crisis that erupted in the fall of that year. For much, much more on this, please see my previous article entitled “Guess What Happened The Last Time The Price Of Oil Crashed Like This?…”
Whether the price of oil crashed or not, we were already on the verge of massive financial troubles.
But the fact that the price of oil has collapsed makes all of our potential problems much, much worse.
As we enter 2015, keep an eye on energy stocks, energy bonds and listen for any mention of problems with derivatives. The next great financial crisis is right around the corner, but most people will never see it coming until they are blindsided by it.
Do you want to know if the stock market is going to crash next year? Just keep an eye on junk bonds. Prior to the horrific collapse of stocks in 2008, high yield debt collapsed first. And as you will see below, high yield debt is starting to crash again. The primary reason for this is the price of oil. The energy sector accounts for approximately 15 to 20 percent of the entire junk bond market, and those energy bonds are taking a tremendous beating right now. This panic in energy bonds is infecting the broader high yield debt market, and investors have been pulling money out at a frightening pace. And as I have written about previously, almost every single time junk bonds decline substantially, stocks end up following suit. So don’t be fooled by the fact that some comforting words from Janet Yellen caused stock prices to jump over the past couple of days. If you really want to know where the stock market is heading in 2015, keep a close eye on the market for high yield debt.
If you are not familiar with junk bonds, the concept is actually very simple. Corporations that do not have high credit ratings typically have to pay higher interest rates to borrow money. The following is how USA Today describes these bonds…
High-yield bonds are long-term IOUs issued by companies with shaky credit ratings. Just like credit card users, companies with poor credit must pay higher interest rates on loans than those with gold-plated credit histories.
But in recent years, interest rates on junk bonds have gone down to ridiculously low levels. This is another bubble that was created by Federal Reserve policies, and it is a colossal disaster waiting to happen. And unfortunately, there are already signs that this bubble is now beginning to burst…
Back in June, the average junk bond yield was 3.90 percentage points higher than Treasury securities. The average energy junk bond yielded 3.91 percentage points higher than Treasuries, Lonski says.
That spread has widened to 5.08 percentage points for junk bonds vs. 7.86 percentage points for energy bonds — an indication of how worried investors are about default, particularly for small, highly indebted companies in the fracking business.
The reason why so many analysts are becoming extremely concerned about this shift in junk bonds is because we also saw this happen just before the great stock market crash of 2008. In the chart below, you can see how yields on junk bonds started to absolutely skyrocket in September of that year…
Of course we have not seen a move of that magnitude quite yet this year, but without a doubt yields have been spiking. The next chart that I want to share is of this year. As you can see, the movement over the past month or so has been quite substantial…
And of course I am far from the only one that is watching this. In fact, there are some sharks on Wall Street that plan to make an absolute boatload of cash as high yield bonds crash.
One of them is Josh Birnbaum. He correctly made a giant bet against subprime mortgages in 2007, and now he is making a giant bet against junk bonds…
When Josh Birnbaum was at Goldman Sachs in 2007, he made a huge bet against subprime mortgages.
Now he’s betting against something else: high-yield bonds.
From The Wall Street Journal:
Joshua Birnbaum, the ex-Goldman Sachs Group Inc. trader who made bets against subprime mortgages during the financial crisis, now has more than $2 billion in wagers against high-yield bonds at his Tilden Park Capital Management LP hedge-fund firm, according to investor documents.
Could you imagine betting 2 billion dollars on anything?
If he is right, he is going to make an incredible amount of money.
And I have a feeling that he will be. As a recent New American article detailed, there is already panic in the air…
It’s a mania, said Tim Gramatovich of Peritus Asset Management who oversees a bond portfolio of $800 million: “Anything that becomes a mania — ends badly. And this is a mania.”
Bill Gross, who used to run PIMCO’s gigantic bond portfolio and now advises the Janus Capital Group, explained that “there’s very little liquidity” in junk bonds. This is the language a bond fund manager uses to tell people that no one is buying, everyone is selling. Gross added: “Everyone is trying to squeeze through a very small door.”
Bonds issued by individual energy developers have gotten hammered. For instance, Energy XXI, an oil and gas producer, issued more than $2 billion in bonds just in the last four years and, up until a couple of weeks ago, they were selling at 100 cents on the dollar. On Friday buyers were offering just 64 cents. Midstates Petroleum’s $700 million in bonds — rated “junk” by both Moody’s and Standard and Poor’s — are selling at 54 cents on the dollar, if buyers can be found.
So is there anything that could stop junk bonds from crashing?
Yes, if the price of oil goes back up to 80 dollars or more a barrel that would go a long way to settling things back down.
Unfortunately, many analysts are convinced that the price of oil is going to head even lower instead…
“We’re continuing to search for a bottom, and might even see another significant drop before the year-end,” said Gene McGillian, an analyst at Tradition Energy in Stamford, Connecticut.
As I write this, the price of U.S. oil has fallen $1.69 today to $54.78.
If the price of oil stays this low, junk bonds are going to keep crashing.
If junk bonds keep crashing, the stock market is almost certainly going to follow.
For additional reading on this, please see my previous article entitled “‘Near Perfect’ Indicator That Precedes Almost Every Stock Market Correction Is Flashing A Warning Signal“.
But just like in the years leading up to the crash of 2008, there are all kinds of naysayers proclaiming that a collapse will never happen.
Even though our financial problems and our underlying economic fundamentals have gotten much worse since the last crisis, they are absolutely convinced that things are somehow going to be different this time.
In the end, a lot of those skeptics are going to lose an enormous amount of money when the dominoes start falling.