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Oil & Gas Headed Lower as Economy Strikes Consumers

by: Michael Filloon October 15, 2008 | about stocks: DIG / DUG / OIL / UGA    

Michael Filloon

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With the large run on the stock market on Monday, many believe that we are out of the woods. The marked pessimism on the economy is probably closer to right as I think there is still more pain around the corner.

Don’t get me wrong, the downside is limited, but equities seem to have little to cheer about and PPI and CPI numbers are coming in particularly low. I believe we will see trading in the 8000-10000 range for some time to come. The main reason for this is not the housing market, as I believe that was placed under control, but the possible global recession that seems to be heading our way. If you thought our housing market was bad, take a look at Europe, as they did very little to get ahead of this problem and are now scrambling to find a bottom to their economy. All of this is bullish for the dollar, but one may want to look to the yen for shelter going forward.

With much of the mortgage mess figured into the market (by my calculations), the current trade is the possible global slowdown and maybe, recession. I do believe we will see a global recession for a few reasons. Two major mining conglomerates stated today that demand was waning out of China. This is after China has not imported any gasoline for the last two months. It is not unreasonable to speculate that China is going to pull back in spending now that the Olympics are over. Some think that China over spent on this endeavor and may many projects in the short term. The possible worldwide housing mess will continue to increase global unemployment, foreclosures and decrease consumer spending.

In every market there are places to look for short term gains. I am not saying that it is a good idea to jump into the market, but this is a good time to play if you like to speculate. Not too long ago, I heard T. Boone Pickens state that he thought oil was going to sixty. At the time I believed he was crazy, now I am not so sure.

This creates some very interesting changes in the economy and thus the market. First, demand decreases as people lose their homes and cars because they cannot make the payments. Auto markets are seeing the same problem as housing; it is just not as obvious. A home was purchased for $500,000, for example. As foreclosures increase, the price of housing goes down as there are more homes than buyers. So those that want to get out of their homes cannot and it doesn’t pay to keep making payments, as the values have plummeted. Those that are going into bankruptcy are also getting rid of their vehicles. Some high priced SUV values have decreased in value by as much as 50%. Many are including these vehicles in their bankruptcies and giving them back to the lending in hopes of finding something smaller that uses less gasoline.

Another factor is unemployment, as costs are being cut as the consumer has gone by the way side. When job cuts take place, people do not drive to work, and that decreases consumption.

Lastly, as US consumers lose jobs, they will not go out and buy discretionary items. Since an estimated 76% of our economy is the consumer, and we are the largest in the world, smaller countries providing cheap labor will also be hit, and the oil that powers their facilities will be used less, which also decreases demand.

OPEC nations are already starting to scream about decreased oil prices and I believe this will continue for some time. We are just starting to see negative GDP numbers and this will lead to continued stress on the oil and gas markets. The continued increases in ethanol usage will also start to push commodity pricing down. Look for Russia to continue to pump large amounts of oil into the system to protect their economy and keep the prices low; this, along with many smaller nations such as Nigeria which have begun to pump offshore to increase surpluses.

If you are looking longer term I would say that the bigger banks, such as Wells Fargo (WFC) and JPMorgan (JPM), are the best positions, but as a trade I would by the UltraShort Oil & Gas ETF (DUG), or short its long counterpart (DIG).

Disclosure: none

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This article has 4 comments:

  •  
    Oct 15 12:33 PM
    Michael you speak the truth, the OPEC countries are hurting while the North Americans get a sigh of relief at the pumps. There are so many factors influencing the recent declines, and it thus it is difficult to pinpoint the areas of the true SOURCE of the matter. A key issue that got us here in the first place that alot of us ignore is the role of the credit agencies. They failed to properly re-assess the mortgages.. and held stead fast on ratings even though AAA were being mixed with CCC toxic bonds. We need to address the ROOTS of the problem rather than catering to the simple symptoms.
    Reply
  •  
    Oct 15 06:53 PM
    The best part about the oil decline is that it encourages OPEC members to cheat on their quotas even more than they already do to support their extravagent gov't spending.
    Reply
  •  
    Oct 19 12:04 PM
    Oil didn't make sense at $148 and it doesnt makes sense at $70. Hot, leveraged money has been running the commodity markets for some times now, not fundamentals. Getting long DUG now or Short DIG makes no sense. This market is uninvestable, but taking the opposite site of the capitulation trade has been very profitable, and will continue to be. I think the better strategy short term is to buy the capitulation moves and sell the following moves back to the 20 day SMA until the things calm down a bit.
    Reply
  •  
    Oct 20 11:45 AM
    Thanks for your comments, I also look forward to oil and gas coming down to a more reasonable level. God Bless.
    Reply
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