The Hightower Report

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CRUDE OIL MARKET FUNDAMENTALS: Energy markets are seeing strong follow through gains after a sharp rally yesterday was triggered by a very bullish inventory report. The energy markets are responding to a shift starting to take place in the market’s fundamental landscape. The unexpected and sharp decline in gasoline stocks and more importantly a stronger pickup in gasoline demand along with another decline in oil imports is an indication that the supply/demand setup may start to tip back toward a balance. Although crude oil is still facing a supply glut with stocks over 50 million barrels above year ago, focus is now on gasoline and concerns that low refinery operations will significantly tighten fuel supplies this spring. With the oil market so beaten down, the fundamental changes for gasoline starting to be reflected in the EIA report seems to have inspired the trade to look beyond the current economic bleakness and start to price in the tremendous amounts of government stimulus being spent to revive the economy. It was particularly bullish to see energy markets yesterday push aside both the very bad economic news and another sharp drop in the equity markets and that suggests the energy markets are starting to pay more attention to internal fundamentals than macroeconomic issues. In fact, bullish sentiment was fanned overnight by a report that the UAE announced sharper supply cuts to Asian customers for April raising speculation that OPEC will certainly cut production at their March meeting. Certainly part of the rally this week in oil has been response to evidence of a high compliance rate by OPEC. With a variety of economic reports due out today, the resolve of the bull camp could be tested and if optimism can hold, we suspect April crude oil may have the technical capacity to rally back to the $47 to $50 price range.

PRODUCT MARKET FUNDAMENTALS: GASOLINE: The gasoline market has extended yesterday’s upward price thrust in the overnight trade. Every aspect of yesterday’s inventory report was bullish for gasoline as the 3.3 million barrel stock decline, a nearly 1% decline in refinery operations and a 1.7% rise in demand shows the fundamentals are starting to turn positive. As a result, gasoline stocks are now 17.5 million barrels below year ago levels leaving gasoline with the best fundamentals setup of the energy complex. With refineries in the midst of a heavy maintenance schedule there is certainly cause for concern for gasoline stocks to tighten sharply into the spring. It may not take too much in the way of a pick-up in gasoline demand to accelerate a fall in gasoline stocks. Since April gasoline looks to have reached a technical oversold extreme near last week’s low the market may have the capacity to rally back towards $1.40 level given the improved fundamental outlook. In fact, a push above $1.2968 could inspire more aggressive chart based buying.

HEATING OIL: April heating oil is being pulled higher by the strength in the rest of the complex. While the market’s fundamentals aren’t as strong as gasoline with distillate stocks still over 20 million barrels above year ago, low refinery rates should help to limit build ups even though demand has yet to show any signs of recovery. With market also technically oversold, we suspect heating oil could see a near-term upside price target of $1.3453 if gasoline continues to provide upside leadership.

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OUTSIDE MARKET DEVELOPMENTS: In the long run, more and more money is chasing less and less products which is a classic formula for inflation. The longer-term fundamentals continue to look positive for the gold and silver markets but a short-term shift to a more optimistic view on equities and some easing in concerns for the banking industry may be seen as short-term negative forces.

GOLD MARKET FUNDAMENTALS: A recovery in banking stocks in Europe this morning and a positive tone to equity markets leaves the market vulnerable to short-term selling pressures. Ideas that other asset classes might out-perform gold over the short-term has added to the selling pressures and holdings in the SPDR Gold Trust have been unchanged since last week from a record high level and some traders believe that profit-taking may cause some redemptions soon. Talk from Bernanke that he has a plan to keep inflation under control as the economy recovers was also seen as a potential short-term negative force. The markets face new data regarding new home sales, Durable Goods and continuing jobless claims today. The economic sentiment seems to be shifting a bit more positive for the short-run as uncertainty over government action is beginning to come down some.

SILVER MARKET FUNDAMENTALS: Silver seems to have been trading exclusively as a precious metal recently and had a similar volatile price pattern to gold in yesterday’s trade. The market has penetrated the steep uptrend channel off of the January and February lows and this may have sparked some of the selling pressures. Testimony by Bernanke seemed to calm both economic and banking sector fears yesterday and helped spark the late break. The market saw a sharp break overnight as banking fears in Europe subsided and futures pushed to the lowest level since February 13th.

PLATINUM: The stock market bounce might support some life to the platinum market but short-term economic data should continue to show significant weakness in the world economy and buyers are reluctant to count on much improvement in industrial demand for quite some time. Look for April gold to gain on April platinum. Short-term resistance for April platinum comes in at $1,068.70 with support back at $1,014 and $988.90.

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DOLLAR: The Dollar has seen narrow and choppy two sided trade overnight. Global equity markets were higher overnight and gold was lower, suggesting a return of investor risk appetite that could diminish the Dollar’s safe haven appeal. But any Dollar weakness from a lack of safe haven support may be limited by the idea that the US is still in the best position to recover first from the global economic recession. In fact, the Dollar may win at the expense of other currencies whose governments are perceived as not doing enough to stem the economic spiral. Bernanke and Obama have pledged that the US government will do everything possible to lift the country out of a recession, and the proactive attempts being made in the US is certainly supportive to the Dollar. In addition, seeing the ECB reluctant to cut aggressively cut rates and the Euro-zone’s banking system risks getting worse could further diminish the appeal of the Euro. Stymied government efforts in Japan to provide an effective stimulus package leaves the country facing a severe and drawn out recession, and this is stripping away the Yen’s status as a safe haven currency. If the US equity market sees some upside traction today, we can’t rule out a dip in the March Dollar back to trendline support at 86.57, but we also get the sense that the Dollar is starting to be viewed in a better light given the US government’s efforts to revive the economy and stabilize the banking sector.

EURO: The Euro has been under a bit of pressure in the early overnight trade, weighed down by more negative economic news from Germany and expectations for the ECB to lower rates next week. While a slightly higher risk tolerance has so far limited overnight losses, we suspect both economic and financial system problems will end up weighing on the currency. The Euro could ultimately be undermined by the 2.1% contraction in Germany’s 4th quarter GDP versus the 3rd quarter and by an ECB member saying the situation in the European banking system remains tense. Therefore, while equity market gains may provide a temporary lift, there seem to be enough problems facing the Euro-zone to suggest that rallies in the Euro won’t hold.

YEN: While the Yen has traded weaker overnight, the aggressive selling seen over the last two session appears to have subsided, and that may allow for a minor price bounce. The market is looking a bit oversold following the sell off over the past two weeks, and some short covering seems reasonable. But the upside potential for the Yen remains limited, and the market is likely headed back toward the 100 price level. It is clear that Japan is facing a severe and protracted recession given recent data showing January exports falling 45.7% compared to year ago. Japan’s worsening recession, ideas that the government has not taken enough steps to stem the economic decline, and the recent political scandals have undermined the Yen’s safe haven appeal. An indication that most of the carry trades have been unwound seems to be another factor weighing on the Yen.

SWISS: The Swiss has seen a choppy two sided trade, but unless broad selling against the dollar emerges, we suspect the market will have trouble sustaining any upside traction. The weak German GDP reading and a sharp decline in Italian retail sales certainly paints a bleak picture of the European economy, and that should ultimately undermine the Swiss currency. We also suspect the uncertainty regarding the issue of Swiss bank secrecy will continue to be a negative factor.

POUND: The Pound is starting to come under some pressure this morning, giving up its earlier gains following a GDP revision indicating that the UK economy contracted at a slightly faster rate in the 4th quarter. The news is seen as paving the way for quantitative easing by the BOE, and that also seen as a bearish factor for the Pound. Part of the Pound’s strength recently has come on the cross trade with the sinking Yen. Therefore, any recovery bounce in the Yen could also add downward pressure on the Pound.

CANADIAN DOLLAR: The Canadian currency is attempting to recover after holding a test of support near 80.00 in the overnight trade. A slight improvement in risk appetites and improved sentiment in global equity markets may help to underpin the currency. The market was able to shake off a weak December retail sales figure yesterday with support for the Canadian coming from the sharp recovery in US equity markets. Gains in oil prices overnight are providing a measure of support, but to fed off ideas of lower Canadian rates ahead, we suspect follow through gains in US equity markets will need to be seen to lift the March Canadian above downtrending channel resistance at 81.03 today.

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It was clear from yesterday’s market action that without the constant support of a safe haven bid, Treasuries are likely to be weighed down by the sheer amount of new debt supply needed to be auctioned. Yesterday’s grim economic news and warnings for a protracted and severe economic recession wasn’t enough for the Treasury market to hold on to early strength since it didn’t stir up fresh economic or financial sector anxiety in the equity markets. While Treasury market direction will continue to be highly influenced by the equity market, we continue to believe that the mountain of debt that the marketplace will need to absorb will ultimately drive Treasury yields up and prices down and that gains on safe haven rallies will provide selling opportunities.

It seems as if a measure of calm was restored to the equity markets yesterday after Fed Chairman Bernanke made assurances that the Fed didn’t need to nationalize US banks to keep them viable. Seeing the gold market continuing to sell off overnight and global equity markets higher also reflects a lower fear factor, and if improved sentiment can hold during the US session, it will likely end up weighing on Treasuries as the market’s focus shifts to the auctions today.

The Treasury will be selling $32 billion in 5-Yr Notes today, and we suspect there will be some concern over whether foreign demand for US debt will remain strong in light of the less than average foreign participation in the 2-Year Note auction yesterday.

In his speech last night, President Obama warned that even more government money will likely be needed to revive the economy. The bull camp case has also been undermined by Bernanke indicating the Fed wasn’t planning at this time to directly purchase longer dated Treasury debt. With the huge amount of supply that will need to be absorbed, we see little upside potential for the bond and note markets.

Today’s report on existing home sales may provide an early safe haven bid to Treasuries. Bernanke testimony to the House Financial Services Committee today has the potential to provide more of a calming effect on financial markets, and that would favor the bear camp in Treasuries.

Unless anxiety levels are revived and there is another steep fall in equity markets today, we suspect any early gains in Treasuries will likely be given up in a post auction trading. As a result, June Bonds look vulnerable to being pushed back to test support at the lower end of the consolidation range.

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The technical action in the market appears to leave hope for at least a short term bounce from an extremely oversold condition. While this could be as short as a few days, the extent of short covering combined with some sidelined money moving into the stock market could cause the bounce to be significant. While entertaining, the President’s speech last night failed to cause a significant reaction in the market from either the bulls or the bears. The more optimistic view on the ability to recover was seen as positive, but the lack of details left the market reaction muted. Statements from Bernanke, however, sparked a major turn higher in the US and world stock markets yesterday, with at least some sentiment that the US is not on the path of nationalizing banks. Strength in auto stocks and hints that China may even double the stimulus plans helped to keep markets firm overnight. Bernanke will be speaking in Washington again today. The longer term problems due to uncertainty in the financial outlook on the economy and on corporate profits and the uncertainty in the political outlook, as the Administration has not been very specific regarding the public involvement in the banking, mortgage and insurance business, may be seen as limiting factors on any bounce. The market’s oversold condition enabled equities to shrug off more bad economic news yesterday, including a record low in consumer sentiment and warnings by Bernanke that a severe economic contraction may not end this year. But the rally in equities gained strength later in the session after Bernanke’s testimony seemed to calm investors’ jitters over the banking system. Bernanke’s made assurances that the Fed didn’t need to nationalize US banks to make them viable. Other calming talk from the FDIC chairman, declaring that all large banks are fine for now, also underpinned equity prices.

S&P 500: The market faces existing family home sales data today, and there is a more upbeat sentiment after the strong gains yesterday. Short covering alone could give us a significant bounce, but the poor outlook for profits and the lack of conviction that the economy will turn higher anytime soon may be back to haunt the market. Talk of reducing the deficit in a matter of years after just passing bills of more than 1 trillion dollars adds more confusion. Watch for bounce for a few days but not much more.

DOW: The market is attempting to bounce from an oversold technical condition, but it is not just the charts which are oversold, as consumer confidence readings dove to a new all-time low in February to 25 from a downward revision of 37.4 on January. The Dow gained 3.32% yesterday, and March futures managed a new low for the move and a higher close. Look for the bounce to last a few days and not a lot more.

NASDAQ: The market appears set to see some type of a bounce, as medical and high-tech companies may fare well in the new economy. Japanese stocks jumped 2.7% overnight after a massive 3-day skid. On the break to new lows for stock markets across the globe, there was not a significant panic of collapse, as some stocks, especially non-financial ones held well above their November lows on this break, which is somewhat of a positive signal.

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A jump in the US dollar and collapsing commodity and world equity markets set the stage for a negative day yesterday, but coffee opened steady and managed to even take out the three previous day’s highs with an impressive run. It seems that the sharp break in futures last week allowed everybody who wanted out of longs “out,” and traders suspect that the break attracted some bargain hunting from trade houses. May coffee closed sharply higher on the session yesterday, and unlike many other commodity markets, coffee managed to hold onto most of the early gains. Ideas that the market is oversold and that coffee demand in general does not suffer much during recessionary times and some talk that end user buying will emerge on the recent break helped to support. The rally is especially impressive given the sharp rally in the dollar and continued weakness in global equity markets. Ideas that producer selling may slow during the Carnival holiday in Brazil along with strong cash basis levels for both Colombia and Central American coffees helped to support. The Commitment of Traders report on the weekend showed that trend following or managed fund traders exited nearly all of their net long positions for the week ending February 17th. This group were noted sellers of 5,383 contracts to end up long just 509 contracts. Exchange stocks had been slipping over the past month, but ICE certified arabica stocks have jumped over the past two sessions, and they were up 3,081 bags from the previous session yesterday to 4.187 million bags, with 19,915 bags pending review. Open interest was up 1,475 contracts to 122,189, which is a positive factor.

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After the weak close yesterday, another move lower today could spark some heavy selling by spec longs and trend-following funds. The gloomy economic outlook is lowering demand expectations for cotton, as new clothes and home furnishings are expected to be low priorities during times of economic uncertainty. While there is a potential for tight supplies next year due to declining plantings and there are hopes that the stimulus programs being enacted across the globe will spark a stronger demand, these are potential longer term developments, while economic worries threaten demand over the near term. May cotton moved to its lowest level since December 12th yesterday, as another round of bearish action in the stock market translated into growing concerns for cotton demand and helped pressure the market late in the day. The market was supported early from solid export sales news last week and a strong stock market overnight. However, a sharp break in the stock market and a surge higher in the US dollar helped spark the selling. Weak export demand could occur with the dollar strength, and demand numbers could still show further revisions lower in upcoming supply demand reports. A lack of new fundamental news kept the volume low. Certified exchange stocks increased to 196,507 from 192,125 contracts the previous session.

TODAY’S GUIDANCE: The technical indicators are oversold, but attracting new buyers (and even avoiding aggressive selling) will be difficult if the stock market stays under pressure.

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May cocoa settled sharply lower on Monday, continuing the price slide from last week amid heavy fund and speculative selling. Given that the market has likely become short term oversold following the steep price decline from the February high, it won’t be surprising to see some degree of short covering in May cocoa. However, we suspect such short covering rally attempts will attract fresh selling, as the market’s technical pattern has turned bearish amid a less supportive fundamental view. May cocoa has fallen below several key support levels since topping earlier this month, and the probe under the January low yesterday leaves the chart setup negative and targets an eventual test of $2,298, which is a 0.618 retracement of the rally from the November low to the February high. The selling in cocoa has become more aggressive as the supply outlook for the Ivory Coast crop has continued to improve. Reports that abundant rains in the Ivory Coast this month have improved growing conditions for the mid crop have undermined cocoa sentiment. Also, a higher flow of cocoa bean arrivals to Ivory Coast ports in recent weeks has helped their main crop supply catch up a bit to last year’s output, with the 2008/09 harvest now less than 19% below year ago compared to over a 40% gap seen in late December. The slide in US equity markets leaves the economic outlook bearish and lowers the demand prospects for a non-essential food commodity such as cocoa. Contributing to a more pessimistic outlook for global cocoa demand are escalating concerns over a deepening economic recession in Europe and a sharp decline in China’s cocoa bean imports in January.

TODAY’S GUIDANCE: It was particularly bearish to see cocoa fall even in the face of a stronger Pound, and that suggest the market’s internal fundamentals, more than currency influences, are driving market direction right now. Short position holders might want to have trailing profit stops in place just in case May cocoa attempts some type of technical bounce, as retracement support comes in just under the $2,300 level. We see limited upside capacity given that the supply outlook for cocoa looks less tight while demand is questionable, and that could eventually pressure May cocoa back to the $2,000 to $2,100 price range.

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Unless there is a turn back up in the stock market or some sign of a bottom in energy prices, the path of least resistance looks down for sugar. Traders have been awaiting increased tender business from India, but this has not occurred yet. In the meantime, the sharp break in energy prices has traders concerned that there may be a shift toward more sugar production and less ethanol production in Brazil. This, along with a potential decline in sugar consumption around the world could help reduce the projected world production deficit for the 2008/09 season. Declining world demand along with the potential for a recovery bounce in India production for the 2009/10 season could quickly shift the current small world production deficit forecast to a surplus. May sugar closed 7 lower on the session yesterday and down 25 points from the highs of the day. A turn down in the stock market and a turn higher in the US dollar helped pressure the market after the early, solid gains. The Indian government is limiting the amount of sugar that private companies can hold in an effort to depress local prices. Weakness in the energy markets after an early bounce and continued concerns that world demand is on a decline were seen as short term negative forces. In addition, the Commitment of Traders report (as of February 17th) showed speculators net long 146,104 contracts, which leaves the market vulnerable to long liquidation selling, especially if last week’s lows are violated. The market closed at 13.57 for May sugar on February 17th, so many of the new buyers are already holding a losing position.

TODAY’S GUIDANCE: While the longer term supply/demand fundamentals look positive, the deepening recession, a higher US dollar and weakening energy prices could shift demand news down and leave futures extremely overbought if outside forces remain weak.

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As of this writing, the markets were once again facing the double negatives of severe financial sector concerns and expectations for a prolonged recession. As we have suggested in a number of recent articles, the intensely complicated financial threat on top of the dismal economic outlook clearly justified the sharp slide in equity prices in November of 2008. Therefore it is not surprising to see global stocks back under pressure, the whiff of deflation in the air and broad based demand destruction dialogue present in a number of commodity markets at this time.

It was certainly disappointing to see the lack of euphoria following the passage of the landmark stimulus/”social reform” package, but apparently the market wasn’t enamored with the amount of classic spending in the plan. It is also possible that residual uncertainty from the unresolved financial sector situation prevented the market from reacting favorably to huge spending bill. It should be noted that talk of nationalizing the US banking system seemed to be viewed as a positive. Even former Fed Chairman Alan Greenspan expressed some support for it, and perhaps that will provide a measure of hope. One would think that the stimulus program will have some benefit, and one would also think that the Obama housing plan will contribute something positive, but with the market seemingly set to revisit the US auto sector travails in the coming weeks and the US Dollar remaining primarily a flight to quality instrument, it would seem like the odds are stacked against physical commodities in the coming weeks. It could be extremely difficult to discount the prospect of further demand destruction in a host of physical commodities in the coming weeks, but we continue to stand by the principle that sharply declining demand and further declines in prices will ultimately result in serious production losses and eventually in tightness in certain commodities.

In an attempt to put a positive spin on things, it should be noted that at recent price levels US gold reserves were worth roughly $253 billion and the US Strategic Petroleum Reserve a little over $28 billion. At last year’s highs, the petroleum reserve could have been worth as much as $84 billion. Without getting into a line-by-line dissertation on US budget expenditures, clearly there are vast sums of money in each annual budget going to programs that could be eliminated if the solvency of the US government were called into question. And while we aren’t suggesting that the US government sell off a national park or auction off battleships, it could, after borrowing an extra trillion extra dollars or so through typical channels, find money and assets it already owns to provide another wave of financial backing. In listing some of the larger US Department of State, Department of Defense and other expenditures as we have it Table 1, we are not suggesting that these programs are wasteful or ineffective. We are merely pointing to some areas within the budget that could be temporarily suspended in order to shore up the credit confidence in the US government.

In short, the US government might be deeply in debt and its citizens might also be deeply in debt, but relatively speaking, the United States is not without residual assets and tremendous wealth!

For other positives indicators, it should also be noted that 1) in the face of the latest deterioration in global macroeconomic concerns, money continued to flow aggressively toward the US, 2) on a weekly basis US retail expenditures for gasoline have now fallen by more than $1 billion from their peak and 3) mortgage rates around the 2009 lows were very close to providing some direct and rather significant assistance to the US economy.

One can’t deny the turmoil facing the US economy, but help is on the way in the form of recently passed government stimulus efforts. Clearly industries are downsizing, but a new way will be found in the capitalist system and ultimately we think it is wrong to bet against the combined efforts of the world’s central banks.

We suspect that another downdraft in commodities prices is to be expected in the remainder of February and into early March, but it remains our opinion this will provide an opportunity for those that want to get short and for those that still want to invest in the best of class commodities. The near term downtrend action should be used to finance longer term call plays.

Over the near term, it is our opinion that the corn market will need to “sell acres” by moving lower. The trade is already ramping up its projected ending stocks figures, and we fear that subsequent USDA reports will persistently yank down demand because of faltering feed and biofuel demand. After a $1,000 per ton rally from the November low to the February high on supply concerns, cocoa may be overpriced now that those concerns are easing. In the soybean complex after months of wondering why demand destruction in feed market wasn’t showing up, we are now beginning to see signs that it did take place, and that prompts us to suggest buying soybean oil and selling meal on a spread. With lower planted area for winter wheat, dry conditions in China and in the southern plains in the US and an outlook for declining production for the coming year, Kansas City wheat could be the best performing grain market in 2009, but it still may be a bit too early for a buy. As for the investing in commodities we have to point to copper as a market ready for long positioning. China and US stimulus may have a short-term positive impact.