Opinion Editorials, December 2015

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It is indisputable that central bank mandates have morphed from just employment/inflation managers to all out asset class manipulators.

One may argue what assets classes those are but it’s pretty clear that anything is up for grabs. The whims of central bank policies are directly affecting equity and bond markets. The trend has been underway for some time – the Fed has increased its hand in the economy over the past decade so it is no wonder that the Fed seems to have a mandate to prop up certain asset classes while depressing others.

The fact that we have come to this in U.S. after two bubbles isn’t surprising.

What is surprising is the extent to which investors not only adhere to this mentality but assist in it. We all know the adage “don’t fight the Fed,” which has been a longstanding unwritten Wall Street law so to speak. But what is now occurring is that Wall Street is following the Fed with disregard to underlying fundamentals.

Yes, there are some investors showing caution, but there are too many investors running with the Fed, which cause enormous swings in the price of different assets. We witness this daily as either prices crash on shorting or jump on short covering. Again the measure of the distortion level is the disparity and inverse relationship of commodities and NASDAQ, which continues despite record low valuations and short interest in one and very high valuations on the other. Money managers have not hid the fact that they are long on beta and short on energy, nor are they shy in piling in the most crowded trade in history: being long on the dollar knowing the U.S. economy is weakening, solely driven by the Fed’s desire to end ZIRP (zero interest rate policy) and because the EU is printing money like mad. They are doing this knowing full well the oil supply story will end as hedges roll off in 2016 and oil remains far below the free cash flow break-even point.

Production is poised to plunge regardless of near term noise from OPEC or any other conjured up media hype to depress commodities. The fact is beyond the day-to-day noise it’s the dollar that is driving things and will continue to regardless of fundamentals in 2016.

I suspect that despite the high probability of U.S. production declines imminently and the restatement of supply and demand by EIA/IEA to more accurately reflect a much smaller oil imbalance than perceived, it will be the dollar that drives prices. In fact today the EIA raised its demand growth for oil in U.S. to 160,000 barrels per day in 2016 from 120,000 barrels per day despite 2015 being 300,000 barrels per day. Unless there is a recession why would demand wane by that much when larger cars are being sold I ask?

On top of this they cut their projection for production levels in 2016 by 570,000 barrels per day, a larger decrease from the previous 520,000 barrels per day. But these figures could still be understating the case.

Take Kinder Morgan, for example, which just announced a 75 percent cut to its dividend, which will open the door to other MLPs on reducing or eliminating dividends. This will have an extraordinary impact on the returns for investors – we are talking billions payouts to investors using MLP’s to supplement income. Kinder Morgan alone pays out $5 billion in dividend income! Investors were burned once by the dramatic fall in equity, but now a virtual elimination of dividend income. But for companies, this will offset the effects of lower oil, helped also by reductions in capex and layoffs.

The MLP space largely worked through the 2008-2009 financial crisis without cutting dividends. This time they won’t be quite as lucky despite the common belief that the economy is good. The systemic rise in debt due to easy money has increased the problem from 2008 and Kinder Morgan’s problems are just one example of it.

Once the charade of propping the economy up through easy money gimmick plays out (and it is beginning to do so as we speak) all the debt piled on by governments and corporations alike will get exposed. The Fed raising rates only accelerates that process.

Still, there is a chance that none of this matters because something else could crop up in 2016 that will mask this upward pressure on prices, whether it be the dollar or Iran or something else to depress oil. Until OPEC forces prices higher or the Fed changes policy, prices probably won’t recover. By 2017 the same bearish media will reverse course as the dollar bubble bursts. Plenty of reasons will be invented to justify these events but no one will admit that the entire asset class distortion that is ongoing is tied to central bankers broadening their mandates and using any means to manipulate assets prices to prop up economies that are now swimming in debt.

Central banks are manipulating equity prices by 20 to 30 percent on the upside, and the same amount for commodities on the downside. But they can’t have it both ways. Sooner or later the house of cards will come tumbling down.

http://oilprice.com/Energy/Energy-General/Inflated-EIA-Data-Could-Keep-Oil-Prices-Subdued-Next-Year.html

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editor@aljazeerah.info & editor@ccun.org