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.
The 8th largest economy on the entire planet is in a state of turmoil right now. The shocking collapse of the price of oil has hit a lot of countries really hard, but very few nations are as dependent on energy production as Russia is. Sales of oil and natural gas account for approximately two-thirds of all Russian exports and approximately 50 percent of all government revenue. So it should be no surprise that the fact that the price of oil has declined by almost 50 percent since June is absolutely catastrophic for the Russian economy. And when you throw in international sanctions, wild money printing by the Central Bank of Russia and unprecedented capital flight, you get the ingredients for an almost perfect storm. But those of us living in the western world should not be too smug about what is happening in Russia, because the nightmare that is unfolding over there is just a preview of the economic chaos that will soon envelop the whole world.
So far this year, the Russian ruble has fallen nearly 50 percent against the U.S. dollar. That is a monumental shift. And as the collapse of the ruble has accelerated in recent days, we are seeing scenes in Russia that are reminiscent of the Weimar Republic. For example, just consider the following excerpt from an article that just appeared in the New York Times…
Scenes that Russians hoped had receded into the past reappeared on the streets: Currency exchange signs blinked ever-changing digits, and Russians rushed to appliance stores to buy washing machines or televisions to unload rubles.
“We are seeing an economic crisis,” Natalia V. Akindinova, a professor at the Higher School of Economics, said in a telephone interview. “We are seeing a sharp devaluation of the ruble at a time when the central bank doesn’t have the reserves to influence the market, as it did in the past crises.”
In a desperate attempt to stop the bleeding, the Central Bank of Russia made an astounding move. Last night it raised its key interest rate from 10.5 percent all the way up to 17 percent.
It was hoped that this desperate move would keep the ruble from plummeting any further.
And it did work for a few minutes, but then the collapse of the ruble resumed. This is how Zero Hedge described the carnage…
For those wondering if the CBR’s intervention in the Russian FX market with its shocking emergency rate hike to 17% overnight calmed things, the answer is yes… for about two minutes. The USDRUB indeed tumbled nearly 10% to 59 and then promptly blew right back out, the Ruble crashing in panic selling and seemingly without any CBR market interventions, and at last check was freefalling through 72 74, and sending the Russian stock market plummeting by over 15%.
So why is this happening now?
Well, the biggest reason for the freefall of the ruble is the fact that the Central Bank of Russia just printed up about 625 billion rubles and gave it to their friends at Rosneft.
Rosneft is an absolutely massive oil company that is controlled by the Russian government. For months, Rosneft has been asking for a bailout (sound familiar?) to refinance loans that can no longer be rolled over with western banks because of economic sanctions.
And on Friday they got one.
In an attempt to quietly slip this massive injection of new money past everyone, Rosneft issued 625 billion rubles worth of new bonds just before the weekend and the Central Bank of Russia gobbled most of those new bonds up with freshly created money. Unfortunately for Rosneft and the Central Bank of Russia, the rest of the world took notice…
With the oil giant in a bind, the central bank ruled that it would accept Rosneft bonds held by commercial banks as collateral for loans.
Rosneft issued 625 billion rubles, about $10.9 billion at the exchange rate at the time, in new bonds on Friday. The identities of the buyers were not publicly disclosed, but analysts say that large state banks bought the issue.
When these banks deposit the bonds with the central bank in exchange for loans, Rosneft will have been financed, in effect, with an emission of rubles from the central bank.
So that is what led to the panic selling that we witnessed on Monday.
Meanwhile, money is being pulled out of Russia at an absolutely staggering pace. As confidence in the ruble and in the Russian financial system disappears, wealthy people are feverishly trying to protect their wealth by moving it somewhere else. The following is an excerpt from an editorial that Mohamed A. El-Erian recently penned for Business Insider…
Rather than bring in buyers at these substantially cheaper levels, Russian currency weakness is inducing more selling, including by a growing number of worried bank depositors who, instead of holding their savings in ruble, are opting for safer dollars. The larger the extent of this “currency substitution,” the bigger the scope for capital flight out of Russia. This puts even greater pressure on the currency, aggravating the output contraction, imported inflation, and the general sense economic and financial instability.
It has been estimated that total capital outflows for 2015 will reach an astounding $128 billion.
And this could just be the beginning of the economic troubles for Russia.
If the price of oil stays this low or goes even lower, the Russian economy will shrink. The only question is how much it will contract…
The Bank of Russia said Monday that the country could sink into a deep recession next year if oil prices remain at $60 a barrel. GDP could contract by as much as 4.7% in 2015, and then by a further 1.1% in 2016 unless oil prices pick up.
Sadly, it isn’t just oil producing nations such as Russia that are going to be devastated by the coming crisis.
Eventually, the entire globe is going to feel the pain.
Last week was the worst week for global financial markets in three years, and so many of the exact same patterns that we witnessed just prior to the great financial crisis of 2008 are happening once again. We have been living in a false bubble of relative stability for the past couple of years, but now time is running out. The next great financial crisis is rapidly approaching, and 2015 promises to be the most “interesting” year that we have seen in ages.
Is this the start of the next major financial crisis? The nightmarish collapse of the price of oil is creating panic in financial markets all over the planet. On June 16th, U.S. oil was trading at a price of $107.52. Since then, it has fallen by almost 50 dollars in less than 6 months. This has only happened one other time in our history. In the summer of 2008, the price of oil utterly collapsed and we all remember what happened after that. Well, the same patterns that we witnessed back in 2008 are happening again. As the price of oil crashed in 2008, so did prices for a whole host of other commodities. That is happening again. Once commodities started crashing, the market for junk bonds started to implode. That is also happening again. Finally, toward the end of 2008, we witnessed a horrifying stock market crash. Could we be on the verge of another major one? Last week was the worst week for the Dow in more than three years, and stock markets all over the world are crashing right now. Bad financial news continues to roll in from the four corners of the globe on an almost hourly basis. Have we finally reached the “tipping point” that so many have been warning about?
What we witnessed last week is being described as “a bloodbath” that was truly global in scope. The following is how Zero Hedge summarized the carnage…
- WTI’s 2nd worst week in over 3 years (down 10 of last 11 weeks)
- Dow’s worst worst week in 3 years
- Financials worst week in 2 months
- Materials worst week since Sept 2011
- VIX’s Biggest week since Sept 2011
- Gold’s best week in 6 months
- Silver’s last 2 weeks are best in 6 months
- HY Credit’s worst 2 weeks since May 2012
- IG Credit’s worst week in 2 months
- 10Y Yield’s best week since June 2012
- US Oil Rig Count worst week in 2 years
- The USDollar’s worst week since July 2013
- USDJPY’s worst week since June 2013
- Portugal Bonds worst week since July 2011
- Greek stocks worst week since 1987
The stock market meltdown in Greece is particularly noteworthy. After peaking in March, the Greek stock market is down 40 percent since then. That includes a 20 percent implosion in just the past three trading days.
And it isn’t just Greece. Financial markets all over Europe are in turmoil right now. In addition to crashing oil prices, there is also renewed concern about the fundamental stability of the eurozone. Many believe that it is inevitable that it is headed for a break up. As a result of all of this fear, European stocks also had their worst week in over three years…
European stock markets closed sharply lower on Friday, posting their biggest weekly loss since August 2011, as commodity prices continued to fall and and shares in oil-related firms came under renewed pressure from the weak price for crude.
The pan-European FTSEurofirst 300 unofficially ended 2.6 percent lower, down 5.9 percent on the week as the energy sector once again weighed heavily on wider benchmarks, falling over 3 percent.
But despite all of the carnage that we witnessed in the U.S. and in Europe last week, things are actually far worse for financial markets in the Middle East.
Just check out what happened on the other side of the planet on Sunday…
Stock markets in the Persian Gulf got drilled Sunday as worries about further price declines grew. The Dubai stock index fell 7.6% Sunday, the equivalent of a 1,313-point plunge in the Dow Jones industrial average. The Saudi Arabian market fell 3.3%.
Overall, Dubai stocks are down a whopping 23 percent over the last two weeks, and full-blown stock market crashes are happening in Qatar and Kuwait too.
Like I said, this is turning out to be a truly global financial panic.
Another region to keep an eye on is South America. Argentina is a financial basket case, the Brazilian stock market is tanking big time, and the implied probability of default on Venezuelan debt is now up to 93 percent…
Swaps traders are almost certain that Venezuela will default as the rout in oil prices pressures government finances and sends bond prices to a 16-year low.
Benchmark notes due 2027 dropped to 43.75 cents on the dollar as of 11:35 a.m. in New York, the lowest since September 1998, as crude extended a bear market decline. The upfront cost of contracts to insure Venezuelan debt against non-payment for five years is at 59 percent, bringing the implied probability of default to 93 percent, the highest in the world.
So what does all of this mean for the future?
Are we experiencing a repeat of 2008?
Could what is ahead be even worse than that?
Or could this just be a temporary setback?
Recently, Howard Hill shared a few things that he looks for to determine whether a major financial crisis is upon us or not…
The first condition is a serious market sector correction.
According to some participants in the market for energy company bonds and loans, such a correction is already underway and heading toward a meltdown (the second condition). Others are more sanguine, and expect a recovery soon.
That smaller energy companies have issued more junk-rated debt than their relative size in the economy isn’t under debate. Of a total junk bond market estimated around $1.2 trillion, about 18% ($216 billion, according to a Bloomberg estimate) has been issued by energy-related companies. Yet those companies represent a far smaller share of the economy or stock market capitalization among the universe of junk-rated companies.
If the beaten-down prices for junk energy bonds don’t stabilize or recover a bit, we might see the second condition: a spiral of distressed sales of bonds and loans. This could happen if junk bond mutual funds or other large holders sell into an unfriendly market at low prices, and then other holders of those bonds succumb to the pressure of fund redemptions or margin calls and sell at even lower prices.
The third condition, which we can’t determine directly, would be pressure on Credit Default Swap dealers or hedge funds to make deposits as the prices of the CDS move against them. AIG was taken down when collateral demands were made to support existing CDS agreements, and nobody knew it until they were going under. There simply isn’t a way to know whether banks or dealers are struggling until the effect is already metastasizing.
I think that he makes some really good points.
In particular, I think that watching how junk bonds perform over the next few weeks will be extremely telling.
Last week was truly a bloodbath for high yield debt.
But perhaps things will stabilize this week.
Let’s hope so, because this is the closest that we have been to another major financial crisis since 2008.
It isn’t just the price of oil that is collapsing. The last time commodity prices were this low was during the immediate aftermath of the last financial crisis. The Bloomberg Commodity Index fell to 110.4571 on Monday – the lowest that it has been since April 2009. Just like junk bonds, industrial commodities are a very reliable leading indicator. In other words, prices for industrial commodities usually start to move in a particular direction before the overall economy does. We witnessed this in the summer of 2008 when a crash in commodity prices preceded the financial crisis in the fall by a couple of months. And right now, we are witnessing what may be another major collapse in commodity prices. In recent weeks, the price of copper has declined substantially. So has the price of iron ore. So has the price of nickel. So has the price of aluminum. You get the idea. So this isn’t just about oil. This is a broad-based commodity decline, and if it continues it is really bad news for the U.S. economy.
Of course most Americans would much rather read news stories about Kim Kardashian, but what is happening to the prices of these industrial metals at the moment is actually far more important to their daily lives. For example, when the price of iron ore goes down that is a strong indication that economic activity is slowing down. And that is why it is so troubling that the price of iron ore has almost sunk to a five year low. The following comes from an Australian news source…
The price of iron ore has held below $US70 a tonne in overnight trade, leaving its five-year low within reach.
At the end of the latest offshore session, benchmark iron ore for immediate delivery to the port of Tianjin in China was trading at $US69.40 a tonne, down 0.4 per cent from its previous close of $US69.70 a tonne and only 2 per cent above the five-year low of $US68 reached a fortnight ago.
This week’s dip back under $US70 a tonne has followed revised forecasts from JPMorgan that suggest the commodity will average just $US67 a tonne next year, about $US20 below the investment bank’s previous expectation.
Copper is probably an even better economic indicator than iron ore is. Economists commonly refer to it as “Dr. Copper”, and there is a really good reason for that. Looking back over history, the price of copper often makes a significant move in one direction or the other before the economy does. And now that the price of copper just hit the lowest level that we have seen since the last financial crash, alarm bells are going off. The following comes from an article by CNBC contributor Ron Insana…
Copper prices are now below $3 a pound and there’s an expression that “the economy is topped with a copper roof.” More simply put, copper tends to top out in price, before it becomes obvious that, in this case, the global economy is about to weaken.
So is the global economy heading for rough waters?
Could 2015 be a very rough year economically?
According to Insana, the signs are all around us…
We already have evidence that the commodity crash has ominous portents for the rest of the world:
* Japan’s recession is deeper than previously thought.
* China’s demand for basic materials, amid a glut of uneconomic construction projects, appears to be plummeting.
* Russia’s ruble has collapsed and the country is on the brink, if not already in, a recession.
* India’s economic recovery is beginning to look shaky.
* Europe’s growth rate and inflation rate, for the next two years, were just revised downward by the European Central Bank, suggesting that Europe’s economic crisis is far from over. In fact, at least one former European leader with whom I recently spoke, believes the crisis in Europe may just be in its early stages.
* Brazil and other emerging market nations are struggling with a variety of issues, from recessions at home, to the rising value of the dollar, which is complicating how emerging markets conduct economic policies at home, given how closely their currencies are tied to the greenback.
In addition, the Baltic Dry Index is now at the lowest point that we have seen at this time of the year since 2008…
Simply put, with collapsing commodity prices (iron ore for instance) and massive fleets of credit-driven mal-investment-based vessels, it should surprise no one that the shipping index just plunged back below 1000, now at its lowest for this time of year since 2008. Furthermore, the seasonal bounce always seen in Q3 was among the weakest ever.
What does all of this mean?
It is commonly said that those that do not learn from history are doomed to repeat it.
So many of the exact same patterns that we witnessed leading up to the financial crash of 2008 are happening again.
Unfortunately, very few people saw the last crash coming, and this next crash will take most Americans by surprise as well.
I have written more than 1,200 articles about the economy on my website since 2009, and right now our financial system is more primed for a crash than at any other time since I started The Economic Collapse Blog.
Hopefully we have at least a couple more months of relative stability, but without a doubt 2015 is shaping up to be the most “interesting” year that we have seen in the financial world in a very long time.
All of the signs are there. But most people choose to believe that everything is going to be okay somehow. When the next crash comes, those people are going to be absolutely blindsided by it.
When you see storm clouds on the horizon, the logical thing to do is to prepare. And the number one thing that most people should be working on is an emergency fund. So don’t be frittering your money away on frivolous things. In the early stages of this next crisis, you are going to need money to pay the mortgage, to put food on the table and to take care of your family.
Just remember what happened back in 2008. A lot of middle class families were living on the financial edge every month, and because they didn’t have any cushion to fall back on, millions of those families ended up losing their homes when their jobs disappeared.
You need to have an emergency fund that can cover at least six months of expenses. You don’t want a job loss or a major emergency to put you into a situation where your family could be put out into the street.
And for those that still have lots of money invested in the stock market – I really hope that you know what you are doing.
The market giveth, and the market taketh away.
And when the market taketh away, the consequences can often be exceedingly cruel.
Are much lower oil prices good news for the U.S. economy? Only if you like collapsing capital expenditures, rising unemployment and a potential financial implosion on Wall Street. Yes, lower gasoline prices are good news for the middle class. I certainly would rather pay two dollars for a gallon of gas than four dollars. But in order to have money to fill up your vehicle you have got to have an income first. And since the last recession, the energy sector has been the number one creator of good jobs in the U.S. economy by far. Barack Obama loves to stand up and take credit for the fact that the employment picture in this country has been improving slightly, but without the energy industry boom, unemployment would be through the roof. And now that the “energy boom” is rapidly becoming an “energy bust”, what will happen to the struggling U.S. economy as we head into 2015?
At the start of this article I mentioned that much lower oil prices would result in “collapsing capital expenditures”.
If you do not know what a “capital expenditure” is, the following is a definition that comes from Investopedia…
“Funds used by a company to acquire or upgrade physical assets such as property, industrial buildings or equipment. This type of outlay is made by companies to maintain or increase the scope of their operations. These expenditures can include everything from repairing a roof to building a brand new factory.”
Needless to say, this kind of spending is very good for an economy. It builds infrastructure, it creates jobs and it is an investment in the future.
In recent years, energy companies have been pouring massive amounts of money into capital expenditures. In fact, the energy sector currently accounts for about a third of all capital expenditures in the United States according to Deutsche Bank…
US private investment spending is usually ~15% of US GDP or $2.8trn now. This investment consists of $1.6trn spent annually on equipment and software, $700bn on non-residential construction and a bit over $500bn on residential. Equipment and software is 35% technology and communications, 25-30% is industrial equipment for energy, utilities and agriculture, 15% is transportation equipment, with remaining 20-25% related to other industries or intangibles. Non-residential construction is 20% oil and gas producing structures and 30% is energy related in total. We estimate global investment spending is 20% of S&P EPS or 12% from US. The Energy sector is responsible for a third of S&P 500 capex.
These companies make these investments because they believe that there are big profits to be made.
Unfortunately, when the price of oil crashes those investments become unprofitable and capital expenditures start getting slashed almost immediately.
For example, the budget for 2015 at ConocoPhillips has already been reduced by 20 percent…
ConocoPhillips is one of the bigger shale players. And its decision to slash its budget for next year by 20% is raising eyebrows. The company said the new target reflects lower spending on major projects as well as “unconventional plays.” Despite the expectation that others will follow, it doesn’t mean U.S. shale oil production is dead. Just don’t expect a surge in spending like in recent years.
And Reuters is reporting that the number of new well permits for the industry as a whole plunged by an astounding 40 percent during the month of November…
Plunging oil prices sparked a drop of almost 40 percent in new well permits issued across the United States in November, in a sudden pause in the growth of the U.S. shale oil and gas boom that started around 2007.
Data provided exclusively to Reuters on Tuesday by industry data firm Drilling Info Inc showed 4,520 new well permits were approved last month, down from 7,227 in October.
If the price of oil stays this low or continues dropping, this is just the beginning.
Meanwhile, the flow of good jobs that this industry has been producing is also likely to start drying up.
According to the Perryman Group, the energy sector currently supports 9.3 million permanent jobs in this country…
According to a new study, investments in oil and gas exploration and production generate substantial economic gains, as well as other benefits such as increased energy independence. The Perryman Group estimates that the industry as a whole generates an economic stimulus of almost $1.2 trillion in gross product each year, as well as more than 9.3 million permanent jobs across the nation.
The ripple effects are everywhere. If you think about the role of oil in your life, it is not only the primary source of many of our fuels, but is also critical to our lubricants, chemicals, synthetic fibers, pharmaceuticals, plastics, and many other items we come into contact with every day. The industry supports almost 1.3 million jobs in manufacturing alone and is responsible for almost $1.2 trillion in annual gross domestic product. If you think about the law, accounting, and engineering firms that serve the industry, the pipe, drilling equipment, and other manufactured goods that it requires, and the large payrolls and their effects on consumer spending, you will begin to get a picture of the enormity of the industry.
And these are good paying jobs. They aren’t eight dollar part-time jobs down at your local big box retailer. These are jobs that comfortably support middle class families. These are precisely the kinds of jobs that we cannot afford to lose.
In recent years, there has been a noticeable economic difference between areas of the country where energy is being produced and where energy is not being produced.
Since December 2007, a total of 1.36 million jobs have been gained in shale oil states.
Meanwhile, a total of 424,000 jobs have been lost in non-shale oil states.
So what happens now that the shale oil boom is turning into a bust?
That is a very good question.
Even more ominous is what an oil price collapse could mean for our financial system.
The last time the price of oil declined by more than 40 dollars in less than six months, there was a financial meltdown on Wall Street and we experienced the deepest recession that we have seen since the days of the Great Depression.
And now many fear that this collapse in the price of oil could trigger another financial panic.
According to Citigroup, the energy sector now accounts for 17 percent of the high yield bond market.
J.P. Morgan says that it is actually 18 percent.
In any event, the reality of the matter is that the health of these “junk bonds” is absolutely critical to our financial system. And according to Deutsche Bank, if these bonds start defaulting it could “trigger a broader high-yield market default cycle”…
Based on recent stress tests of subprime borrowers in the energy sector in the US produced by Deutsche Bank, should the price of US crude fall by a further 20pc to $60 per barrel, it could result in up to a 30pc default rate among B and CCC rated high-yield US borrowers in the industry. West Texas Intermediate crude is currently trading at multi-year lows of around $75 per barrel, down from $107 per barrel in June.
“A shock of that magnitude could be sufficient to trigger a broader high-yield market default cycle, if materialized,” warn Deutsche strategists Oleg Melentyev and Daniel Sorid in their report.
If the price of oil stays at this level or continues to go down, it is inevitable that we will start to see some of these junk bonds go bad.
In fact, one Motley Fool article recently stated that one industry analyst believes that up to 40 percent of all energy junk bonds could eventually go into default…
The junk bonds, or noninvestment-rated bonds, of energy companies are also beginning to see heavy selling as investors start to worry that drillers could one day default on these bonds. Those defaults could get so bad, according to one analyst, that up to 40% of all energy junk bonds go into default over the next few years if oil prices don’t recover.
That would be a total nightmare for Wall Street.
And of course bond defaults would only be part of the equation. As I wrote about the other day, a crash in junk bonds is almost always followed by a significant stock market correction.
In addition, plunging oil prices could end up absolutely destroying the banks that are holding enormous amounts of energy derivatives. This is something that I recently covered in this article and this article.
As you read this, there are five “too big to fail” banks that each have more than 40 trillion dollars in exposure to derivatives. Of course only a small fraction of that total exposure is made up of energy derivatives, but a small fraction of 40 trillion dollars is still a massive amount of money.
These derivatives trades are largely unregulated, and even Forbes admits that they are likely to be at the heart of the coming financial collapse…
No one understands the derivative risk positions of the Too Big To Fail Banks, JP Morgan Chase, Citigroup, Bank of America, Goldman Sachs or Morgan Stanley. There is presently no way to measure the risks involved in the leverage, quantity of collateral, or stability of counter-parties for these major institutions. To me personally they are big black holes capable of potential wrack and ruin. Without access to confidential internal data about these risky derivative positions the regulators cannot react in a timely and measured fashion to block the threat to financial stability, according to a National Bureau of Economic Research study.
So do we have any hope?
Yes, if oil prices start going back up, much of what you just read about can be averted.
Unfortunately, that does not seem likely any time soon. Even though U.S. energy companies are cutting back on capital expenditures, most of them are still actually projecting an increase in production for 2015. Here is one example from Bloomberg…
Continental, the biggest holder of drilling rights in the Bakken, last month said 2015 output will grow between 23 percent and 29 percent even after shelving plans to allocate more money to exploration.
Higher levels of production will just drive the price of oil even lower.
At this point, Morgan Stanley is saying that the price of oil could plummet as low as $43 a barrel next year.
If that happens, it would be absolutely catastrophic to the most important industry in the United States.
In turn, that would be absolutely catastrophic for the economy as a whole.
So don’t let anyone tell you that much lower oil prices are “good” for the economy.
That is just a bunch of nonsense.
There has only been one other time in history when the price of oil has crashed by more than 40 dollars in less than 6 months. The last time this happened was during the second half of 2008, and the beginning of that oil price crash preceded the great financial collapse that happened later that year by several months. Well, now it is happening again, but this time the stakes are even higher. When the price of oil falls dramatically, that is a sign that economic activity is slowing down. It can also have a tremendously destabilizing affect on financial markets. As you will read about below, energy companies now account for approximately 20 percent of the junk bond market. And a junk bond implosion is usually a signal that a major stock market crash is on the way. So if you are looking for a “canary in the coal mine”, keep your eye on the performance of energy junk bonds. If they begin to collapse, that is a sign that all hell is about to break loose on Wall Street.
It would be difficult to overstate the importance of the shale oil boom to the U.S. economy. Thanks to this boom, the United States has become the largest oil producer on the entire planet.
Yes, the U.S. now actually produces more oil than either Saudi Arabia or Russia. This “revolution” has resulted in the creation of millions of jobs since the last recession, and it has been one of the key factors that has kept the percentage of Americans that are employed fairly stable.
Unfortunately, the shale oil boom is coming to an abrupt end. As a recent Vox article discussed, OPEC has essentially declared a price war on U.S. shale oil producers…
For all intents and purposes, OPEC is now engaged in a “price war” with the United States. What that means is that it’s very cheap to pump oil out of places like Saudi Arabia and Kuwait. But it’s more expensive to extract oil from shale formations in places like Texas and North Dakota. So as the price of oil keeps falling, some US producers may become unprofitable and go out of business. The result? Oil prices will stabilize and OPEC maintains its market share.
If the price of oil stays at this level or continues falling, we will see a significant number of U.S. shale oil companies go out of business and large numbers of jobs will be lost. The Saudis know how to play hardball, and they are absolutely ruthless. In fact, we have seen this kind of scenario happen before…
Robert McNally, a White House adviser to former President George W. Bush and president of the Rapidan Group energy consultancy, told Reuters that Saudi Arabia “will accept a price decline necessary to sweat whatever supply cuts are needed to balance the market out of the US shale oil sector.” Even legendary oil man T. Boone Pickens believes Saudi Arabia is in a stand-off with US drillers and frackers to “see how the shale boys are going to stand up to a cheaper price.” This has happened once before. By the mid-1980’s, as oil output from Alaska’s North Slope and the North Sea came on line (combined production of around 5-6 million barrels a day), OPEC set off a price war to compete for market share. As a result, the price of oil sank from around $40 to just under $10 a barrel by 1986.
But the energy sector has been one of the only bright spots for the U.S. economy in recent years. If this sector starts collapsing, it is going to have a dramatic negative impact on our economic outlook. For example, just consider the following numbers from a recent Business Insider article…
Specifically, if prices get too low, then energy companies won’t be able to cover the cost of production in the US. This spending by energy companies, also known as capital expenditures, is responsible for a lot of jobs.
“The Energy sector accounts for roughly one-third of S&P 500 capex and nearly 25% of combined capex and R&D spending,” Goldman Sachs’ Amanda Sneider writes.
Even more troubling is what this could mean for the financial markets.
As I mentioned above, energy companies now account for close to 20 percent of the entire junk bond market. As those companies start to fail and those bonds start to go bad, that is going to hit our major banks really hard…
Everyone could suffer if the collapse triggers a wave of defaults through the high-yield debt market, and in turn, hits stocks. The first to fall: the banks that were last hit by the housing crisis.
Why could that happen?
Well, energy companies make up anywhere from 15 to 20 percent of all U.S. junk debt, according to various sources.
It would be hard to overstate the seriousness of what the markets could potentially be facing.
One analyst summed it up to CNBC this way…
“This is the one thing I’ve seen over and over again,” said Larry McDonald, head of U.S strategy at Newedge USA’s macro group. “When high yield underperforms equity, a major credit event occurs. It’s the canary in the coal mine.“
The last time junk bonds collapsed, a major stock market crash followed fairly rapidly.
And those that were hardest hit were the big Wall Street banks…
During the last high-yield collapse, which centered around debt tied to the housing sector, Citigroup lost 63 percent of its value in the following 60 days, Kensho shows. Bank of America was cut in half.
I understand that some of this information is too technical for a lot of people, but the bottom line is this…
Watch junk bonds. When they start crashing it is a sign that a major stock market collapse is right at the door.
At this point, even the mainstream media is warning about this. Just consider the following excerpt from a recent CNN article…
That swing away from junk bonds often happens shortly before stock market downturns.
“High yield does provide useful sell signals to equity investors,” Barclays analysts concluded in a recent report.
Barclays combed through the past dozen years of data. The warning signal they found is a 30% or greater increase in the spread between Treasuries and junk bonds before a dip.
If you have been waiting for the next major financial collapse, what you have just read in this article indicates that it is now closer than it has ever been.
Over the coming weeks, keep your eye on the price of oil, keep your eye on the junk bond market and keep your eye on the big banks.
Trouble is brewing, and nobody is quite sure exactly what comes next.
Americans are going to spend more than 600 billion dollars this Christmas season, and on Friday we got to see our fellow citizens fight each other like rabid animals over foreign-made flat screen televisions and Barbie dolls. As disgusting as this behavior is to many of us, there may soon come a time when we will all fondly remember these days. Most Americans are completely unaware of what is currently happening in the financial world, but right now there are deeply troubling signs that we could be on the verge of another major global financial collapse. If the next great economic downturn does strike in 2015, that could mean that we may have just witnessed the last great Black Friday celebration of American materialism. As you read this, stock prices are approximately double the value that they should be, margin debt is hovering near all-time record highs, and the “too big to fail” banks are being far more reckless than they were just prior to the last major stock market implosion. So many of the exact same patterns that we witnessed back in 2007 and 2008 are repeating right now, and as you will see below, this includes a horrifying crash in the price of oil. Anyone with half a brain should be able to see the slow-motion financial train wreck that is unfolding right before our eyes.
Every year, it has been my tradition to write an article about the mini-riots that erupt in retail stores all around the country on Black Friday. This year things were a bit calmer because so many stores opened up on Thanksgiving itself, but there was still plenty of chaos. For example, in the video posted below you can see women viciously fighting one another over discounted lingerie and underwear…
But instead of launching into another diatribe about how we are committing national economic suicide by buying hundreds of billions of dollars of foreign-made goods with money that we do not have, I want to focus on what is coming next.
You see, I believe that in the not too distant future many of us will be wishing for the days when the debt-fueled U.S. economy was healthy enough for people to be wrestling with one another on the floor over good deals in our retail establishments.
The next great financial crash (which many have been anticipating for years) is rapidly approaching. So many of the same things that happened last time are happening again. As I noted above, this includes a crash in the price of oil.
In the months prior to the last stock market collapse, the price of oil began plummeting dramatically in the summer of 2008. This was an “early warning signal” that something was deeply amiss in the financial world…
Many people assume that a lower price for oil is good for the economy, but the exact opposite is actually true. The oil industry has become absolutely critical to the U.S. and Canadian economies. And in recent years, the “shale oil boom” has been one of the only bright spots for the United States. If the shale oil industry starts to fail because of lower prices, a lot of the boom areas all over the nation are going to go bust really quickly and a lot of the financial institutions that were backing these projects are going to feel an immense amount of pain.
Unfortunately for us, the “shale oil revolution” simply does not work at 80 dollars a barrel.
And it certainly does not work at 70 dollars a barrel.
As I write this, U.S. crude is sitting at about 66 dollars a barrel due to OPEC’s recent decision to not cut output.
That is the lowest price for U.S. crude since September 2009.
So just like we saw during the summer of 2008, crude oil prices are collapsing once again. The chart below comes from the Federal Reserve, but it is a few days out of date. Now that the price of crude is down to about 66 dollars, you have to imagine the price actually going below the bottom of this chart…
Needless to say, this price collapse is having a huge impact on the stock prices of oil companies. The following information about what happened in the markets on Friday comes from Business Insider…
Here were some of the biggest losers on Friday:
- BP (BP), down 5%
- Royal Dutch Shell (RDS.A), down 6%
- Total (TOT), down 5%
- Statoil (STO), down 14%
- Exxon Mobil (XOM), down 5%
- ConocoPhillips (COP), down 9%
- Marathon Oil (MRO), down 13%
- Occidental Petroleum (OXY), down 7%
- Anadarko Petroleum (APC), down 14%
- Linn Energy (LINE), down 13%
- Whiting Petroleum (WLL), down 28%
- Oasis Petroleum (OAS), down 32%
- Kodiak Oil & Gas (KOG), down 28%
And this list goes on.
But this could just be the beginning of the oil price declines.
The most powerful oil official in Russia believes that the price of oil could fall below $60 next year…
Russia’s most powerful oil official Igor Sechin said in an interview with an Austrian newspaper that oil prices could fall below $60 by mid-way through next year.
Sechin, chief executive of Rosneft, Russia’s largest oil producer, also said U.S. oil production would fall after 2025 and that an oil market council should be created to monitor prices, the same day the OPEC cartel met in Vienna and left its output targets unchanged.
“We expect that a fall in the price to $60 and below is possible, but only during the first half, or rather by the end of the first half (of next year),” Sechin told the Die Presse newspaper.
And one oil industry analyst just told CNBC that he believes that the price of oil could ultimately plunge as low as $35 a barrel…
“When you look at the second half of 2015, that’s when you see oil beginning to dwarf demand by about a million, a million and a half barrels a day,” he said. “Thirty-five dollars is a possibility if they don’t get an agreement next spring because that’s when the oil really starts to build and you can have a billion barrels of oil with really no place to put it.”
This comes at a time when there are already a whole host of signs that the global economy is slowing down. Three of the ten largest economies on the planet have already slipped into recession, and the economic nightmare over in Europe just continues to get even worse. In fact, we just learned that the unemployment rate in Italy has shot above 13 percent for the first time ever recorded.
In addition, it is important to remember that the “real economy” in the United States is in far worse shape than it was just prior to the last financial crash. Just consider these numbers…
-In the United States today, the number of payday lending locations is greater than the number of McDonald’s and the number of Starbucks.
-One recent survey found that about 22 percent of all Americans have had to turn to a church food panty for assistance.
-This year, almost one out of every five households in the United States celebrated Thanksgiving on food stamps.
-The rate of government dependence in America is at an all-time high and approximately 60 percent of U.S. households get more in transfer payments from the government than they pay in taxes.
-According to a report that was just released by the National Center on Family Homelessness, the number of homeless children in the U.S. has soared to a new all-time record high of 2.5 million.
If things are this bad now, what are they going to look like after the next great financial crash?
And without a doubt, the next crash is coming. Hopefully we have at least a couple more months of relative stability, but many experts are now urgently warning that time is quickly running out.
By this time next year, Black Friday may look a whole lot different than it does today.