Please note: This will be the last Morning Energy Blog until August 21st. I will be on vacation with my two teenage daughters trying to do some bonding, if that’s even possible with teenagers.

Equites and the Economy

As I mentioned yesterday, the global equities market got hit with a tsunami yesterday when Monday night the Chinese government devalued the yuan by 1.9% to stimulate the economy there. The move hit U.S. stocks with the Dow falling 212 points, 1.21%, to 17,402, the S&P 500 closing down 20, 0.96%, at 2,084 and the Nasdaq ending of 65, 1.27%, at 5,037. European markets got crushed even more with France’s CAC 40 losing 1.86% and Germany’s DAX getting absolutely bludgeoned falling 2.68%. Now as a matter of background, although the currency move was inordinately large, one could make an argument is was overdue. Most emerging market currencies have weakened this year including Malaysia’s, Indonesia’s and South Africa’s which are at their lowest in well over a decade. China’s yuan has actually risen by more than 18% in trade-weighted and inflation adjusted terms against currencies of its trading partners since the middle of last year. Another example, Japan’s yen has weakened 50% vs. the dollar since 2012. Importantly, most central banks appear to be willing to give Beijing the benefit of the doubt on this move hoping it will spur an economic recovery in the world’s second largest economy and eventually lift all boats. Chinese officials stated this is a one off move as its switching to a more market based benchmark for the currency. All that being said, the move brought confusion to the global markets and confusion brings contempt which results in investors scurrying for safety.

Don’t ever believe the Chinese. Ever! Never! They stated yesterday’s devaluation was a one-off which was an outright lie for overnight the People’s Bank of China devalued the yuan another 1.6%. The yuan has now fallen 3.6% vs. the dollar in just two days and is at its weakest level in four years. There is a real fear now of a currency war, where countries artificially weaken their currencies to gain a competitive advantage, between China and Japan. Both countries are heavily dependent upon exports and with recent economic data out of China showing things are quite ill there, China is taking action. They’ve tired other forms of QE, such as lowering reserve requirements and lowering interest rates, which hasn’t worked very well and now they’re bringing out the big guns by devaluing their currency. The Chinese are not happy that over the past 3 years the Yuan/Yen rate has gone effectively from 20 yuan/yen to 12. What’s quite worrisome to me folks is there may be more to come.

One thing for sure, China is unequivocally letting the world know things are not going economically well there. Consequently investors are bailing out of riskier assets, like equities, faster than greased lightning. The European markets are taking the brunt of the currency hit, and Germany is the bull’s eye. As I mentioned, the bellwether index, the DAX, fell 2.68% yesterday and is down 2.28% today. Here in the U.S. things aren’t much better with Dow futures down 180 points. By the way, emerging market equities are getting destroyed. The MSCI Emerging Market equity index is currently at its lowest monthly close since mid-2012. I need to add that from a pure technical standpoint, material technical damage has been done recently to all the major U.S. index charts.

The big question now is that with equities under pressure how will the Fed react. The Fed Funds Futures, which is where folks bet on future interest rate moves, is falling sharply which suggest investors are betting an interest rate increase in September is less likely.

Oil

Two things happen when the yuan is devalued, and they are both bad for commodities. First, the devaluation implies economic ills in China which means lower demand. Second, the dollar strengthens which is bearish commodities priced in U.S. dollars, which includes oil. Yesterday oil got hammered with WTI closing down $1.88, 4.2%. at $43.08, new 6+ year low. Brent fared better falling $1.23, 2,4%, settling at $49.18. Yesterday OPEC released a report showing that its members continue to boost supplies with production at 31.51 million bpd in July. Iran’s output increased the most since June 2012. Interestingly, Saudi Arabia said it cut production in July by 200,000 bpd to 10.36 million bpd, down from June’s record rate. With the rising dollar, the Chinese slowdown and the global supply gut, estimated at 2.28 million bpd, prices continue to remain under pressure. That being said, I don’t believe there’s good risk/reward for shorting WTI at current price levels. The 6 year closing low was set on March 17, 2015 at $43.46 with a 6 year intraday low set the next day at $42.03. We’re pretty close to those levels right now. This morning WTI is up 55¢ which is pretty impressive considering the destruction occurring in the equities market.

Courtesy of MDA Information Systems LLC

Natural Gas

Yesterday’s morning weather forecast trended marginally cooler sending natural gas prices 5¢ lower in the morning and then the noon update flip flopped trending warmer bringing in buyers and when the market closed it was a push with natty closing 0.2¢ up on the day at $2.844. Interestingly, the deferred contracts got hit yesterday with the calendar 2020 strip and further out trading 6¢ lower. Looks like somebody was doing some hedging and with liquidity limited in those far off time frames it doesn’t take much for bids to vanish. The weather forecast this morning is showing temps to continue to rise in the 6-15 time frame for the northeast which is bringing in some buyers this morning and natty is up 4.6¢. Natural gas prices have risen almost 20¢ in less than 2 weeks and closing in on $2.90 on the heels of really strong demand in the electric generation sector. We’re past the historical hottest time of the year and with CDD’s diminishing each week it will be real interesting to see the EIA storage reports.

Elsewhere

Talk of an El Nino this fall and winter is getting more and more prevalent with unusual phenomenon occurring such as feed fish in the western Pacific moving further out to sea thereby limiting sea lions’ food source to an anomalous invasion of crabs on the beaches of Orange County, California. Well here’s further evidence of the growing El Nino. Due to lack of rainfall caused by the El Nino officials managing the Panama Canal have been forced to limit the draft of container ships to 39 feet. This affects about 18.5% of vessels passing through the waterway. That’s not immaterial amigos! The last time ship size was restricted was 17 years ago in 1998. Supply chain experts say the new restrictions could force shipping lines traveling from Asia to the U.S. East and Gulf Coasts via the canal to leave cargo behind in order to reduce draft. Even a small amount of delayed cargo can have a far reaching impact. For example, manufacturing companies waiting on key components could be forced to shut down temporarily. By the way, the Panama Canal expansion project is expected to be completed next year. I can promise you this will not be the last time you hear from me about this year’s El Nino.

Have a good day.