As vaccines roll out, we edge closer towards seeing the light at the end of the tunnel, the end of the pandemic. We are still far away but there is hope that immunizations will help in getting life back to normal. Looking back one thing that has stood out has been the inordinate amount of liquidity that has been pumped by central banks to do anything in their power to make sure equities and asset markets did not collapse. Other than pumping in excess of $30 trillion into the world economy, governments have handed out free checks to everyone to boost consumer demand and support permanent job losses. This excess of liquidity and free money in the system can never come without any consequences, despite attempts by the Fed to say otherwise. This so-called liquidity, and "checks", have found their way back into the equity market as bored stay at home citizens find other means to entertain themselves, hence, the rise of online retail traders! It has gotten so out of hand that retail and their leverage via options can group together and take down hedge fund short positions, create havoc in illiquid stocks, and everything seems bubbly, as "nothing can ever go down". These are dangerous times and people trading it are those that have not known a market otherwise.
The Fed has created a monster in the system after flushing the system with excess liquidity. The market is like a Jenga Tower, as bigger institutions hold a careful combination of bonds, equities, rates, and commodities... any break down in correlation of the assets causes a domino effect across all asset classes. Everything cannot simply just go up, if it does, then my point, something snaps. All the short illiquid stocks are going up relentlessly. To top it off, most companies in the U.S. are unable to make earnings or have a valid product, and are now using their surplus cash on the balance sheets to buy bitcoin. In essence, all these companies become one big stub trade on the bitcoin! Where and how does all this end?
One important feature of 2020 was the massive Chinese credit growth stimulus program. We all know China went full throttle and pumped trillions of yuan just to get their economy back to a 6% average GDP growth rate. This meant a massive surge in infrastructure development programs - the fastest way to show a boost in economic numbers - as demand for raw materials anywhere from steel, iron ore, and copper would all feed down into the system. But from November, something changed. Aggregate financing in November was 2.13 trillion yuan ($326 billion), financial institutions offered 1.43 trillion yuan of new loans in the month, slightly lower than estimates of 1.45 trillion yuan. The growth in outstanding credit eased to 13.6% as of the end of November from 13.7% in the previous month, while growth in outstanding loans slowed to 12.8% from 12.9%. December numbers showed the same "stalling" slower credit growth. Prior to Covid-19, they had been in deleveraging mode. There has been talk about slowing down in 2021. The Global PMI and money supply numbers for January have showed the same slowing down trend. Could it be that China is taking its foot off the pedal for now?
As we started the year, every sell side analysts suggested to chase the value trade over growth. As yields rise, investors chase Financials, Energy, and cyclicals. However over the past few weeks, it is only Oil and Oil Equities that have been moving higher and not Metal and Mining stocks. Something does not add up.
China was buying oil cargoes back in October and November when Brent Oil was trading at $37/bbl. They restocked when prices were low. The oil market had an excess of 1.5 bln barrels in March, and that has now come down to 500 million barrels. Prices recovering for the market to normalize is not the same thing as a market that is in deficit. Remember it has only stayed here because Saudi Arabia have taken an additional 1 mbpd out of the market in February and March, hoping to sell higher. Demand has not recovered fully yet everyone is buying oil here to play the "reflation" trade.
End of the day, the oil market is not a stock like GameStop (GME) or another illiquid Russell 2000 stock, its physical market is way too big to be manipulated. Fundamentals do matter. Every day that passes by, producers are selling the back end of the oil curve, locking in their production at higher prices. This means more, not less, oil is coming. Now with China showing signs of slowing down, it is only a matter of time when other OPEC+ producers want to jump and sell their barrels before it's too late.
It is important to follow the macro trends like growth over value rotation, or reflation vs. deflation trade. But it is also important to distinguish the top down move from the bottoms up drivers, both need to be in sync for prices to move in the same direction. Copper is one of the tightest markets with a deficit balance, and it has stopped moving higher. That in and of itself is proof enough of who is chasing oil here, too late as usual.
