Last week the petroleum complex swung wildly back and forth in the same old range and is rallying again but could the larger macroeconomic forces at some point get us out of this range?
Nouriel Roubini, the noted economist, reported in today's Financial Times that, "The mother of all carry trades faces an inevitable bust." Roubini says that this massive rally has been helped by a wave of liquidity from near-zero interest rates and quantitative easing. But a more important factor fuelling this asset bubble is the weakness of the US dollar, driven by the mother of all carry trades. Roubini says that the US dollar has become the major funding currency of carry trades as the Fed has kept interest rates down for a long time. Investors who are shorting the US dollar to buy on a highly leveraged basis higher-yielding assets and other global assets are not just borrowing at zero interest rates in dollar terms; they are borrowing at very negative interest rates -- as low as negative 10 or 20 per cent annualized -- as the fall in the US dollar leads to massive capital gains on short dollar positions. In other words, traders are borrowing at negative 20 percent rates to invest in a highly leveraged basis on a mass of risky global assets that are rising in price due to excess liquidity and a massive carry trade. Every investor who plays this risky game looks like a genius even if they are just riding a huge bubble financed by a large negative cost of borrowing. Yet Roubini warns, "One day this bubble will burst, leading to the biggest coordinated asset bust ever: if factors lead the dollar to reverse and suddenly appreciate -- as was seen in previous reversals, such as the yen-funded carry trade -- the leveraged carry trade will have to be suddenly closed as investors cover their dollar shorts. A stampede will occur as closing long leveraged risky asset positions across all asset classes funded by dollar shorts triggers a coordinated collapse of all those risky assets -- equities, commodities, emerging market asset classes and credit instruments. A must read in today's Financial Times.
Oil is rallying mainly because the dollar is getting weaker. Still the bulls may point to some data out of China. Bloomberg News reported that China's manufacturing expanded at the fastest pace in 18 months and a government researcher said economic growth will accelerate this quarter. The Purchasing Managers' Index rose to a seasonally adjusted 55.2 in October from 54.3 in September, the Federation of Logistics and Purchasing said today in an e-mailed statement in Beijing. An index of export orders climbed to 54.5 from 53.3.
Yet on the bearish side Bloomberg News is reporting that the, "Organization of Petroleum Exporting Countries raised crude-oil production last month to the highest level in 10 months as members took advantage of higher prices." A Bloomberg News survey showed output averaged 28.76 million barrels a day in October, up 80,000 barrels from September, according to the survey of oil companies, producers and analysts. The entire gain came from the 11 OPEC members with quotas, all except Iraq. The 11 countries pumped 26.31 million barrels a day, 1.465 million barrels above their target. Iraqi output was unchanged. OPEC cut output quotas by 4.2 million barrels to 24.845 million barrels a day last year as fuel demand tumbled during the worst recession since the 1930s. The group, which left the targets unchanged at a Sept. 9 meeting in Vienna, is set to meet again on Dec. 22 in Luanda, Angola.
Remember last week when it was reported that Saudi Arabia decided to drop the widely used West Texas Intermediate oil contract as the benchmark for pricing its oil and use the Argus sour crude index instead. I said that the NYMEX/CME Group may want to get ready to create a sour crude contract or buy the trading rights to the Argus contract just to be sure. Well guess what the CME Group announced on Friday. They will offer trading in Argus Sour Crude Index futures after Saudi Arabia's state-owned oil producer said it will abandon the company's main crude contract amid viability concerns. The CME will offer cash-settled swap futures on the index beginning Nov. 23.
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