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Prepared by Philip Gotthelf

Crude Oil Hits $50/bbl

(May 26, 2016) July Crude oil reached above $50/bbl this week, leading market gurus to conclude that the worst is over. Large short-side bets will need to be covered very soon as the July contract expires. This is believed to be putting more upside pressure on crude. Gasoline prices have jumped at the pumps in time for the Memorial Day weekend. Many economists are saying, "Hurray!" But, there is a dark side to this rally. The price jump for fuel has been dramatic and quick. Already, consumers are taking defensive positions.

I have repeatedly pointed out that high energy prices are a double-edged sword. When prices fall, consumers have more discretionary cash to spread around into the general economy. Transportation fuel surcharges decline to expand shipping company profit margins. Airlines take in wider margins because of lower fuel costs. Chemical costs decline along with plastics and crude-related feedstocks. The "trickle-down" effect is enormous. Thus, when crude oil prices move up the reverse takes place… but, Big Oil gets fatter and jobs abound in the various oil patches. The fracking industry rebounds and oil exploration accelerates.

Which has the more dominant positive impact? Judging by the stock market, you might conclude higher priced crude is better than lower. That is how the story is being presented now. Historically, this has not been the case. Each time we have had an oil price spike consumers have suffered and shut down. The result is a consumer-driven recession. This is not to say that the relationship is exclusive or absolute. To be sure, other factors influence consumerism besides high energy costs. Further, the trickle-down effect should not be underestimated. From the tar used by roofers to asphalt used for roadways, everything starts to cost more.

This "cost-push" inflation is outside of the Federal Reserve's (FED) control. It is a form of inflation that does not respond well to interest rate policy. This does not mean that the FED won't be happy to see inflation and that the Treasury won't rejoice about paying cheapened Dollars back to debt holders. It does mean that the FED cannot direct the consequences of this form of inflation.

Fundamentally, crude oil continues following at a high rate and demand is being held in check by conservation efforts and skittish Western European and North American economies. The alleged recovery still hasn't produced enough economic growth to reabsorb workers who have quit looking for employment and are not counted among the unemployed. Nearly 50 million citizens are on food stamps. We are far from being out of the economic woods.

Consumers don't want to use more gasoline than they have to.

I was watching a little known OTC stock called Lapolla Industries, Inc.; stock symbol LPAD. I happen to have gotten some shares as a repayment in lieu of cash and I have been following energy conservation for decades… since the 1970's energy crisis. Lapolla makes spray foam insulation. It can reduce heating and air conditioning costs by as much as 30% for average homes and commercial structures. The stock has moved from 20¢ to 55¢ even as the cost of foam has gone up with crude oil. The push comes from sales and perhaps the attractiveness of LPAD for take-over. I am focused upon increasing use of energy conservation.

From the Toyota Prius to Energy Star promotions, Americans are aggressively pursuing conservation. The slowing of fossil fuel consumption combined with advanced exploitation points to a secular price decline. The alternative argument postulates that the West may be slowing down the rate of consumption growth, but China and India are going to offset any such declines while adding more demand going forward.

You may assume I am providing a longer term perspective relative to trading now. I point out that crude oil has become even more fundamentally reactionary. In July, 2014 crude traded above $107/bbl. Within six months it crashed below $50/bbl. The move to $50/bbl could reverse in an instant. Based upon current consumption, there is no supply squeeze. The discussion of shuttering wells is exaggerated. It costs more to cap a well than to keep it running and I have spoken with many of the oil sector financing people who have been willing to extend operating overheads in anticipation of a price recovery. Indeed, the gamble is paying off for the moment.

The Political Hedge

With Donald Trump as the "presumptive" Republican candidate, his talk of bombing ISIS oil resources represents a real potential for 2017. He has crept past Hillary Clinton in national polls and the real mud slinging hasn't even begun, yet. If "President" Trump authorizes strikes against ISIS resources, my military friends tell me ISIS is likely to retaliate with strikes against competitive installations. They may even be as bold as to take out some Saudi facilities. Within an instant, we could see an all-out assault upon Middle East crude oil production, bringing a new price spike that can easily take us back to 3-digit oil.

Given this possibility, many institutional investors like commodity hedge funds along with supply chain hedgers are poised to jump into a long-side hedge. This may intensify as the presidential campaigns proceed. Even if Donald Trump does not gain in polls, President Obama may be forced to deal with ISIS in a "Trump-like" manner simply to offset the Donald's rhetoric. This political hedge is more than reactionary. It sets the stage for energy policy in any new administration.

This is very important. Consider the contrast between Hillary and Donald. Hillary has declared a continuation of the war on coal and fossil fuels. It has cost her in the coal belt states as well as among the new fracking states. Millions of direct and downstream jobs are at stake. Hillary has practically promised new Federal regulations against fracking and says she will limit offshore drilling. Her ties to the Clinton Foundation are direct. That foundation was originally founded to promote green initiatives. It has expanded its mandate to a more general proposition of promoting health and well being along with supporting women's equality and quality-of-life initiatives. Initiative is a key word. If you search the Clinton Initiative you will see that Clinton Foundation origins are very much intact.

To be sure, Hillary's true motives are far more complicated than Donald's. Without invoking politics, the objective review of the Clintons' actions relative to their words shows that they may be friendlier to the global fossil fuel political structure than to our domestic programs. The Clinton Foundation has received millions from Middle East oil interests. That's no secret. Republicans try to hype the women's rights issue because they presume it will help to get the female vote. That's the stupidity of politics. Trump hasn't a clue, yet. He is likely to pull from the same superficial political argument.

The real Clinton position suggests an effort to maintain the prior global energy infrastructure with a heavy reliance upon foreign oil… mostly from OPEC producers. The Clinton Initiative has actually encouraged other regions to employ fracking. The curbing of domestic fossil fuel supports external sources of fossil fuels. This means that U.S. energy independence is far more calculated under a potential Clinton presidency. With Trump, we are not sure… but, he's a "businessman." His limited discussion on the subject appears to take the "Drill baby drill!" approach. No matter, there could hardly be more of a difference between Hillary and Donald at this time.

Technical Considerations

Many chartists believe July crude oil has already broken out. The weekly chart displays a double bottom this year leading to a "V" formation.

The rise from the bottom has been rapid and impressive. Notice that re are up against resistance on the weekly continuation chart. A breakout above 5265 points to a rally up to 6250 resistance. From there, the weekly chart shows clear sailing back towards 9000. This is why the bulls are so enthusiastic. They are certain resistance will succumb to bullish momentum.

The monthly continuation chart supports the weekly, showing resistance at 6500. This would be enough to restart the moribund fracking industry… but for political pull-back.

Fracking moratoriums abound. News of serious manmade earthquakes in Oklahoma has ignited a storm of controversy over the fracking process. Anti-fracking groups are screaming, "You see?! YOU SEE?!" The great hope for U.S. energy independence has been turned back from a reality to simply a hope. This is not to say that fracking can't survive under current rules and regulations. It is to say that state legislatures and governors are less likely to fully embrace a technology that could contaminate ground water and cause devastating earthquakes. I would not be surprised if President Obama preempts Hillary by invoking Executive Action to intervene in the clear and present environmental dangers caused by fracking.

All this looks positive for the crude oil price trend. Still, other newly producing nations like Colombia, Brazil, and even marginal regions like Australia are not inclined to follow the U.S. lead. They will move full speed ahead to continue developing and exploiting fossil fuel resources. So, the U.S. may lose the energy independence initiative to other producers depending upon which politics come into play.

Commodity Inflation

Some argue that commodity inflation is exactly what the FED is looking for. Corn has moved above $4.00/bu, making farmers happy. This is particularly welcome since chemicals and fertilizer will be more costly from the pop in oil. But, corn is responding to severe weather across the central plains that could adversely impact newly planted fields. Flooding and washouts could hinder the 2016 crop.

As of this writing, we remain short July corn and July soybeans with a close stop in corn for sure. By the time Friday rolls around, we could be out of both positions, but resistance has been evident in both commodities. From a consumer's perspective, the decline in cattle and hogs represents more than an offset in the grains. Severe weather could upset that trend if storms happen to hit concentrated production areas as we saw with 1999 hurricane Floyd in the Carolinas. Many hog farms were wiped out and the immediate result was a sharp price decline as remaining animals were sold to raise cash or reduce overheads. Once the dust settled, hog prices soared from the resulting shortages.

"Be careful what you wish for!..." The expression pertains to the FED and its quest for inflation. If commodity prices are pushed higher and consumers balk, we could easily see a recession before summer ends. Behavioral psychologists warn that "unfavorable" numbers for Trump and Clinton translate into negative moods. In turn, the public at large is prone to negative thinking that can exacerbate a consumer shutdown. One thing can feed upon the other. We would end up with stagflation… higher prices (inflation) and poor economic performance (stagnation/recession).

The Wall Street Journal front page highlighted "Health Insurers Seek Rate Hikes." The article appeared in the Business & Tech section and pointed to Obama Care as the principle cause for premium increases. These will come on top of already huge hikes for deductibles and, co-pays. This burden directly hits the middle class and small business. With projections of 20% and more in rate hikes, there is no way we won't see consumers pulling back and businesses cutting back. Trust me when I say the "central planning" of Uncle Sam has gotten us into a pickle!

May 26, 2016
Philip Gotthelf
Commodity Futures Forecast
P.O. Box 566, Closter, New Jersey

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