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0 Jun 23 2011 @ 10:58am by Matt Smith in Capital Markets, Crude Oil, Global Energy, risk management, Risk Strategy

Similar Flavors in Market Ingredients

It’s not that financial markets aren’t always a conundrum (they are), but their current cohesion is a conundrum in itself. Looking across key assets and aspects of the economy – from manufacturing to house prices to employment to our dearly beloved commodities – market ingredients are leaving a similar taste – of waning optimism. So here’s some current market themes, of course wrapped in an energy-flavored tortilla:  

First on the chopping board, the industrial side of things. The bounce from recessionary levels has been strong, with consistent expansion in both the manufacturing sector (a number above 50 for the last 22 months, below), and year-over-year growth in industrial production for 17 months. However, the big concern is the recent downturn seen in both these indices, as slowing growth / expansion take hold:     

Industry is key to natural gas, as industrial demand makes up approximately 30% of its total usage. The EIA projects that industrial demand for natural gas will grow by 3.1% this year; however, it has actually remained predominantly below last year’s level until recently (according to Bentek), while the above chart does not bode well for the EIA’s projection going forward. 

Next we take a look at employment, which is following a similar recipe to manufacturing. Yes, we have seen a return in job creation, but not only has this job creation been relatively lackluster (lest we forget, 121,000 jobs need to be created each month just to keep up with population growth), but job creation is stuttering and apparently slowing, just like the manufacturing sector:

And perhaps the weakest looking indicator of all: housing. House prices have troughed, bounced, and are now back showing year-over-year price depreciation again. This is a result of continued foreclosures flooding the market, despite the accomodative back drop of low borrowing rates; the 30-yr mortgage rate is back at 4.5% after all, near seven-month lows:

Finally, bringing it all back to energy. Headline crude prices have run up this year on turmoil in the Middle East and a broadly improving global economy, before recent economic worries have spurred on a solid bout of selling. However, the recent rally and subesequent reversal in US gasoline prices highlight the fragility of the US economy. After reaching a peak of $3.985, prices have now retreated nearly 10%, indicative of an economy which may have underlying strength, but not enough strength to maintain demand for gas at $4/gal: 

So where does this leave us? Not in such a state of doom and gloom as the case I have presented may appear. The industrial sector is still showing expansion (albeit slowing), while jobs are being created (albeit slowly). As for housing, a bear market lasting half a decade means we are getting close to bottoming out. And as for energy, natural gas prices are being very much driven by a strong supply picture, rather than industrial demand which is in structural decline. Meanwhile, we should see support for crude prices for the rest of the year, reflecting a picture of a growing global economy – and one which should help the US avoid a double dip recession.

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