Monday, May 20, 2013 – Daily Scandals and Distractions

Daily Scandals and Distractions
by Sinclair Noe
DOW – 19 = 15,335
SPX – 1 = 1666
NAS – 2 = 3496
10 YR YLD + .02 = 1.96%
OIL + .58 = 96.87
GOLD + 33.90 = 1395.10
SILV + .66 = 23.02
I suppose we should start with the scandal du jour, since this is where most of the news has been fixated recently. I’ll try to focus on how it affects the economy and the markets, but it’s hard to ignore the bluster. One quote I heard over the weekend was “add Watergate and Iran Contra together and multiply by ten” to calculate the tyrannical evil of the Obama scandals.
Actually, the current scandals are not even close (I’m old enough to remember the enemies list and plumbers). I don’t think the scandals are inconsequential but I think some historical perspective might help. The rhetoric without perspective might actually backfire. But what we concern ourselves with here is the economic and financial impact. And it’s likely there will be limited economic impact. We’ve seen worse, and the markets survived and sometimes even prospered.
Remember Iran Contra? It happened to coincide with one of the greatest bull runs the market has ever seen. And remember the Lewinsky scandal? It coincided with a market that was described as irrationally exuberant; this is often attributed to gridlock in Washington, or some sort of moderation. Actually, the old idea of gridlock being good for markets, doesn’t really hold water.
When one party controls both the White House and Congress – Republicans or Democrats – the markets perform about 5 times better than when the president and Congress are from opposite parties. It doesn’t seem to matter for the current administration; the market is enjoying big gains, with the S&P 500 up 149% since the lows of March 2009. And when things look bad, the market goes higher.
The explanation may come from the Federal Reserve. Weak numbers on any front are viewed as a sign that the Fed will remain accommodative as will other central banks around the world. The old adage “don’t fight the fed” has really become “don’t fight the feds’ – as in plural. Trillions of dollars on the sidelines have to be put to work and are hungry for yield, especially from stocks. 
The trillions of dollars worth of central banks stimulus has put into play the past few years have socialized risk. The game used to be private gains and private losses. Now it’s private gains and socialized losses. Businesses that have under-invested for years are beginning to capitalize on a distracted Washington using the breathing room to make new investments.
Anyway, the markets appear to be propped up, for now at least.
Remember the Libor rate rigging scandal? Several of the biggest banks were rigging Libor, the interest rate that is used worldwide for just about everything. When the Libor Scandal broke it raised the question, what else is rigged? We learned that derivatives, specifically the nearly $400 trillion dollar market in interest rate swap prices were subject to possible manipulation of the ISDA fix.
The latest revelation is oil price rigging. A review ordered by the British government last year in the wake of the Libor revelations cited clear” parallels between the work of the oil-price-reporting agencies and Libor.
They are both widely used benchmarks that are compiled by private organizations and that are subject to minimal regulation and oversight by regulatory authorities. To that extent they are also likely to be vulnerable to similar issues with regards to the motivation and opportunity for manipulation and distortion.
Last week, the European Commission raided the offices of Shell, BP and Norway’s Statoil as part of an investigation into suspected attempts to manipulate global oil prices spanning more than a decade. None of the companies have been accused of wrongdoing, but the controversy has brought back memories of the Libor rate-rigging scandal.
The inquiry also involves Platts, the world’s largest oil price reporting agency.Europeans have long complained that retail gas prices have not seemed to match wholesale prices. In fact, complaints that retail prices at gas stations were noticeably slow to fall when wholesale prices fell prompted the U.K.-based Office of Fair Trading last year to conduct a cursory inquiry into possible anti-competitive behavior in the fuel markets.Early this year, they announced that they hadn’t found enough evidence to warrant a full-blown investigation. But complaints persisted.
Reuters points out that the probe may be expanding to the U.S.:

In Washington, the chairman of the Senate energy committee asked the Justice Department to investigate whether alleged price manipulation has boosted fuel prices for U.S. consumers.

Efforts to manipulate the European oil indices, if proven, may have already impacted U.S. consumers and businesses, because of the interrelationships among world oil markets and hedging practices,” Sen. Ron Wyden (D-Ore.), chairman of the Senate Energy and Natural Resources Committee, wrote in a letter to Attorney General Eric H. Holder Jr. Wyden also asked Justice to investigate whether oil market manipulation was taking place in the United States.”

Not only are petroleum products a multi-trillion dollar market on their own, but manipulation of petroleum prices would effect virtually every market in the world.
There’s a lot riding on the price of oil, including how much money OPEC nations need to keep their governments funded. At $100 a barrel, there’s enough profit to produce the oil and to fund the governments. Things get dicey around $80 a barrel; $60 dollar a barrel oil spells big problems for almost all OPEC countries.
Meanwhile, the International Energy Agency (IEA) in its Oil Market Report claimed that America’s shale boom is growing even larger than expected. It’s also set to have a profound effect on OPEC.OPEC is also set to produce, or have the capability to produce, a lot more oil. One main driver of that supply growth is Iraq. After a turmoil-filled decade, Iraq is coming back on line in a big way — and could add another 3 million barrels per day to the oil mix by 2018.
So the U.S. has lots of oil, and we’re producing it at an ever-growing rate. And OPEC has a lot of oil and is either producing it or sitting on it.

And what’s funny is that if OPEC continues to cut supply via quotas, all it will do is help the U.S. oil boom. They’ll essentially be crimping supply to boost prices… and we’ll benefit. So why are prices still high? Central banks are still printing money. The Fed and the BOJ are printing away, and it’s probably only a matter of time before the ECB joins in. Maybe that explains something. Then there is the fear premium. Then there is the idea that prices are rigged. Nobody wants to upset the situation, at least not right now.

The Saudis aren’t happy that Iraq is coming online with about 3 million barrels a day by 2018. This could lead to a round of infighting among OPEC — with each nation trying to eke out the most money. Frankly, the Saudis have massive incentive to see Iraq fail. The same goes for Iran. There are sanctions against Iranian oil, and that has as much to do with the price of oil as any specific act of craziness from the Iranian crazies.
The U.S. and OPEC are set to produce much more oil. And even though US and Euro demand is falling, demand from the oil-thirsty East is set to ramp up. So, we have an uneasy equilibrium in the oil markets right now.
The Federal Reserve Bank of San Francisco points out: When gasoline prices increase, a larger share of households’ budgets is likely to be spent on it, which leaves less to spend on other goods and services. The same goes for businesses whose goods must be shipped from place to place or that use fuel as a major input (such as the airline industry). Higher oil prices tend to make production more expensive for businesses, just as they make it more expensive for households to do the things they normally do.
Oil prices indirectly affect costs such as transportation, manufacturing, and heating. The increase in these costs can in turn affect the prices of a variety of goods and services, as producers may pass production costs on to consumers. Oil price increases are generally thought to increase inflation and reduce economic growth.
Oil price increases can also stifle the growth of the economy through their effect on the supply and demand for goods other than oil. Increases in oil prices can depress the supply of other goods because they increase the costs of producing them. In economics terminology, high oil prices can shift up the supply curve for the goods and services for which oil is an input. One major area that could feel the pinch is agriculture, and the prices of the food we eat.
There are some important scandals, just don’t get distracted.

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