Juggling Dynamite

OPEC President Chakib Khelil said that had it not been for the weak dollar, political tensions and speculation, oil prices would probably be around $70 a barrel. “In terms of fundamentals, there is no problem of supply and demand. There is much more a bubble due to speculation, which is based on a depreciating dollar and geopolitical tensions,” Khelil said yesterday.
See Current Oil Prices are unjustifiable.
Saudi Arabia yesterday called for an urgent meeting of oil producing and consuming countries to discuss what it called the “unjustifiable rise in oil prices.” It also offered to coordinate with the Organization of Petroleum Exporting Countries (OPEC) and other major producers to ensure adequate supply in order to curb prices.
Co-ordinated top down efforts to support the dollar and curb speculation, along with ongoing demand destruction from a slowing global economy will ultimately prevail to drive commodity prices down from recent heights. Once it begins in earnest, the velocity of the correction is likely to be shock the many that have been conditioned by a 5 years bull run to expect only upside in these markets.
Beware of those selling “long-term” investment stories. We must survive the short term before we can benefit in the longer-term.

Source FRB: Federal Reserve
The problem with the Feds acting as back stop for the junk paper dealers is that now almost half of the Fed vault is full of junk. In just the past 12 months, Fed holdings have slipped from 92% AAA treasuries to just 57% AAA with the remaining 33% a varied assortment of “mystery meats.”
This begs the question: how much junk can the Feds absorb without sacrificing their own financial credibility?
It’s not as if the problems have now been solved. Today the Bank of International Settlements warned of continued banking woes:
“Strains in money markets will probably stay “severe well into the future'' as banks struggle to raise cash and credit-market losses deepen.”
“The reluctance of banks to lend to each other for fear one may collapse may slow a recovery in developed countries, the bank said. Banks have suffered $387 billion in losses and write-downs since the start of 2007.” It is likely that there are many more billions of losses to come.
Meanwhile on June 11 the U.S. Securities and Exchange Commission may recommend that Moody's Investors Service, Standard & Poor's and Fitch Ratings be prohibited from advising investment banks on how to earn top rankings for asset- backed securities:
“They basically sold ratings to the highest bidder without any regard to the performance of the rated securities,'' Mason, a former U.S. Treasury Department economist who's now chair of the banking department at Louisiana State University's E.J. Ourso College of Business, said in an interview. “The agencies did not know how to rate these instruments.''
And now in a stroke of further genius the investment banks have swapped these wrongly rated instruments on to the Federal Reserve… In the end tax payers are left holding the empty calories of all the junk that made the financial firms such fat, although fleeting, profits.

Lately the antics of traders racing back and forth between oil and the US dollar have been particularly schizophrenic. Each morning brings a brand new vote as capital floods out of the dollar and into oil, or back to oil and out of the dollar. On Tuesday US Fed Chairman Bernanke prompted a big dollar rally (and corresponding fall in oil which is priced in US $) as he described US inflation as “significantly higher” than the US would like to see it. This sounded an “all on the dollar trade” bell as speculation roared that the US Fed may be done cutting rates and may soon be tightening again in an effort to slow inflation.
Yesterday, an opposite catalyst came from European Central Bank President Trichet's comments (see video clip) that the ECB may look to increase rates in the near term as it struggles to squeeze down inflation to its mandated 2% target rate. The ECB already has an overnight rate of 4% more than double that of the US, and this has been one of the key forces driving the Euro to escalating highs against the U$ over the past several months. So the dollar fell back on such news, and oil (again) spiked in response to catch up for currency weakness.
This week as oil spiked the energy heavy Canadian Index topped fresh highs. But before we Canadians bring on the marching band, let us see one thing clearly. The parabolic spike in the price of oil is not a good thing for anybody. It is not a healthy sign of a strong global economy. As I have said many times of late, recent jumps in the price of oil have nothing to do with consumption demand. If anything constructive is coming from rocketing prices, it is that consumers all around the world are in fact quickly reducing consumption.
Soon it is likely that Asian governments who also heavily subsidize their domestic oil prices will scale back on this increasingly costly enterprise and let oil prices float up. This will plunge weakening demand even further as has already been happening in western countries where subsidies are lower. We can be sure that the “invisible hand” will eventually correct overzealous prices.
This week we also received further confirmation that gasoline prices face an even greater downside price risk than crude oil. US auto sales have plunged as gas prices have peaked, and as such US gas demand has now fallen to its lowest level in more than 10 years.
See BCA:US gasoline demand destruction ahead.
Meanwhile if we look at recent inflation data around the world we have reason for considerable alarm. In my view, we also have ample reason to expect that central bankers will be unable to cut rates much further in this climate.
“In China, Thailand, the Philippines and at least eight other Asian economies, benchmark borrowing costs are lower than the rate of inflation [in the US too], resulting in negative real interest rates, according to data compiled by Bloomberg. The risk is that prices will spiral even faster, leading to overheated economies and an eventual bust.”
For some recent inflation statistics: see China leads Asia in retreat from inflation battle
China: may accelerate to 10 % as early as this month
Brazil: inflation exceeds 5%
Russia: consumer prices up 14% in April from year earlier
Indonesia: 10% expected by year end
Vietnam: up 25% in May
The spiralling prices threaten the credit ratings of emerging-market nations, Fitch Ratings said in a report May 27. Russia is the most vulnerable of the so-called BRIC economies, which also include Brazil, China and India; in Asia, Vietnam and Sri Lanka are among the top 10 at risk, according to the report.
High inflation is a cancer on world stability. Leaders all over the world will be focused first on stemming this disease, even at the expense of restricting further economic growth. When push comes to shove they must target inflation as the greater evil. As Marie Antoinette and many other leaders have learned the hard way, when people can't afford basic necessities they rise in revolt.