The best way to describe the recent stock market upswing is a “dash for trash.”
Left by the wayside are growth companies like the FANG stocks – Facebook Inc. (FB), Amazon.com Inc. (AMZN), Netflix Inc. (NFLX), and Google Inc. (GOOG) – now Alphabet Inc. Instead, the sectors that led the rebound were the most beaten-down of all – energy and metals.
As I said not long ago, 2016 will be a year for the “reversion to the mean” trade. In other words, what was hot won’t be and vice versa.
But it looks like this move up in energy and metals is running out of steam. After all, the move was 100% based on hope – not on fundamentals. In fact, in both sectors, the fundamentals are, at best, unhinged.
Oil, Oil Everywhere
Take everyone’s favorite sector all of a sudden – oil.
Long term, production cuts are needed for any up move in price to be sustained. Waiting for the first producer to blink in this share war is like waiting for Godot.
Overproduction is still in the one million-barrel-per-day range, with no cuts in sight.
Both Saudi Arabia and Russia have only agreed to freeze output at record levels. And Iran has said “leave us alone” until they up their output to pre-sanction levels of around 4 million barrels per day. Current Iranian oil output is below 3 million barrels per day.
Then we come to the U.S. shale producers and their fracklog. That’s the process where the wells are drilled, but the oil is left in the ground.
U.S. companies are just waiting for oil to reach $40-plus per barrel in order to bring these wells online. This type of well can be brought to life within 80 days.
There are now roughly 4,000 fracklogged wells in the United States. Andrew Cosgrove of Bloomberg Intelligence estimates that if fracklog were reduced by a mere 170 wells per month, it would add 400,000 to 600,000 barrels per day to an already-glutted market.
The Oil Price Is Capped
And don’t doubt these wells will be brought back online.
You see, U.S. oil executives have a very big incentive to do so. A big chunk of their bonus is based on oil output. The Wall Street Journal reported that many U.S. producers base as much as 75% of executives’ bonuses on production and reserve growth goals.
It puts new meaning behind the slogan, “Drill, baby, drill.”
Another reason for oil prices going nowhere is that the producers themselves don’t believe it.
U.S. shale producers have used this Wall Street-driven speculative rally in oil to hedge their production and lock in current prices.
The Financial Times reports that the number of active U.S. oil futures for delivery in December 2017 has soared by 40% since January alone. The benchmark December 2017 contract was trading in the $46-per-barrel range.
Bottom line: Yes, oil may have bottomed. But it’s going nowhere fast. It will remain capped in the $40-per-barrel range.
Metals Are Just as Bad
Now, let’s turn our attention to the industrial metals – copper, nickel, zinc, iron ore, and aluminum – which have also been on a tear.
Sadly, there’s been no change in those fundamentals, either. As with oil, the major producers refuse to cut output. The result remains – a supply overhang.
Everyone was so excited to see iron ore soar recently. It rose 20% in one day as Chinese demand seemed to be back. But as it turned out, Chinese steel producers were buying so much iron ore because they had to crank out steel in a hurry.
You see, thanks to a big international flower show in the heart of China’s steel country, Tangshan, all steel mills were being shut down from late April to October to reduce pollution. So the steel companies had to produce as much steel as they could in a short period of time.
So much for Chinese iron ore demand being back. The outlook for other metals such as copper and nickel isn’t good, either.
The chairman of the world’s largest copper producer – Chile’s Codelco – is Oscar Landerretche. You’d think he’d try to talk prices up. Instead, he told Bloomberg the glut would persist through 2017.
Landerretche added that he expected the price of copper would go back down to a range of $2 to $2.10 per pound. Wall Street speculators had pushed copper all the way to near $2.28 per pound, and it’s still around $2.21 per pound.
The story is similar in nickel.
The chairman of Russia’s Norilsk Nickel, Pavel Fedorov, told the Financial Times that up to 25% of global nickel production needed to be shut down in order to bring the market into balance. Norilsk Nickel is the world’s biggest nickel producer.
Fedorov added, “If other producers don’t behave rationally, then prices will remain low until rational behavior returns to the market.”
Good luck with that, Mr. Fedorov. We’re in an age of irrationality. An age where every producer is waiting for the next guy to make the hard cuts.
This is an age where Wall Street is like a small child with his hands over his ears, screaming, “No,” – as it blocks out the fundamentals from intruding on the stock market rally.