An Each Way Bet on Oil Prices and Interest Rates

This week’s Daily Reckoning kicks off with a warning on oil prices.

Since bottoming early this year at just under US$50 a barrel, the Brent crude price has jumped to US$66.50, that’s a rise of around 40% in under four months.

But beware. This rise has come from a speculative buying surge. While supply and demand fundamentals ultimately drive the oil price, speculative activity in the futures market can have a big impact on short term price movements.

The chart below, from Saxo Bank, shows the ratio of long and short bets by hedge funds in the Brent crude market, with the Brent price the blue line on the chart.

A ‘long’ position means a bet on higher prices while a ‘short’ position is a bet on lower prices. On 21 April, there were 6.4 longs to every short, an extreme level. In the past, this has led to price corrections.


oil prices

Source: Saxo Bank

Click to enlarge


The thing is, despite the recent rally, oil remains in a down trend and you have to be wary of this continuing. Given that all the speculators are on the same side of the boat right now, it seems like the right time for the downtrend to reassert itself.

There are bigger issues than the oil price in Australia this week. Tomorrow, the RBA meets to decide on interest rates. You could make a case for the bank to go either way. A recent uptick in economic strength says the RBA should hold off for another month.

However the longer term headwinds look formidable. In addition, the recent strength in the dollar is a concern. The RBA may want to cut now to help knock it back down.

The big problem is the housing market. Because Australia’s economy is highly dependent on interest rate stimulus, the only area where monetary policy really ‘works’ is in the housing market. Auction clearance rates were again near record highs in Sydney and Melbourne on the weekend.

Property rises are booming at a time where wages and national income growth is all but non-existent. That’s not healthy. The gains are interest rate driven as capital searches for a decent yield, ignoring risks as it does so.

The RBA wants the benefits of lower rates but not the increased risks to financial stability that lower rates bring.

So they’ll be happy to hear the government has followed up on an earlier announcement to crack down on foreign investors buying up established residential property. From the ABC:

‘Foreign investors who have illegally bought Australian properties have been told to declare themselves by December or risk facing tough new penalties including three years’ jail and fines of up to $637,500.

‘The Federal Government unveiled the new measures today, arguing authorities had failed to properly police laws making it illegal for foreigners to buy established homes in Australia.

‘Under the changes, foreign buyers who breach the rules will face three years in jail and fines of $127,500 for individuals and $637,500 for companies.

‘Third parties, including real estate agents and developers, who knowingly help those buyers will also be penalised with fines of up to $42,500 for individuals and $212,500 for companies.

This is sensible policy. Clearly, there were no deterrents to the existing law being adhered to, so the threat of new fines and jail sentences should take some heat out of the market in the coming months. And, happily for the government, it should add some much needed revenue to the coffers.

On top of these Federal regulations, Victoria is set to announce that foreign investors will pay a further 3% stamp duty surcharge and 0.5% in additional land taxes.

The only surprise is that it took the government (both Federal and State) so long to target foreign investors to raise extra revenue. We’ll soon see whether they’ve killed the golden goose…

As an aside, in a recent issue of Cycles, Trends and Forecasts, Phil Anderson shows how to get the most out of the goose without killing it. It explains why Singapore is one of the wealthiest nations on earth.

August 7, 1965, marks the birth of the global economy’s most successful startup. IBM? Microsoft? Nope. Singapore. On that day, Singapore divorced Malaysia and went on its own.

Since then, Singapore’s growth in real GDP per capita has been 1356%. For the world in general, growth has been 146%, and the US since 1965 has grown a mere 96%. On a purchasing power basis, Singapore’s GNP now ranks second to Qatar.

Any nation’s primary resource is its land. Or more particularly, what that land can be made to generate. A nation’s primary wealth is the accumulation of its economic rent.

The founders of Singapore were smart.

Anyone can own land in Singapore but only under leasehold conditions. Your lease payment is based on the rental value of the land. The economic rent, in other words. It is paid by you to the government. That means the rent generated by labor, working on land, can never ever leave the country.

‘This is why taxes in Singapore can be much lower than other countries.

Even smarter, the founders of Singapore took this economic rent collection ability away from politicians and ensured its collection by a sovereign wealth fund.

Phil’s newsletter is full of fascinating insights like this. If you want to check it out, go here.

Unfortunately, Australia’s economic planners aren’t that smart. The great shame is that western democracies don’t do long term planning. They’re reactive, not proactive.

The move to deter foreign buyers is a reactive attempt to free up room for further interest rate cuts. The politicians want to get the economy growing again to take pressure off the budget.

Speaking of which, The Australian reports today on work done by Deloitte Access Economics.

Commonwealth deficits will total $150 billion over the next four years — almost $50bn worse than official forecasts — with next week’s budget to reveal further massive shortfalls in tax revenues as spending blows out to its highest level in 30 years.’

For all the talk about budget cuts and austerity, there’s really none of it. Government spending continues to increase in part because most of the spending is locked in — it’s structural. That’s why there’s increasing concern about Australia’s AAA credit rating. A few more years of doing nothing, and we will lose it.

That’s why there’s such a massive reliance on monetary policy.

So, should you expect an interest rate cut tomorrow? Who knows, the RBA has been far from consistent lately. A cut now would suggest a whiff of panic around the boardroom. Governor Glenn Stevens likes to talk about ‘confidence’ as being the missing ingredient in Australia’s attempt to recover from the mining boom and bust. Cutting rates after some reasonably decent economic data might bring into question what little confidence people have.

On the other hand, there’s the east coast housing boom to worry about. The RBA can afford to wait another month, and probably should do so. It would give APRA boss Wayne Byers enough time to announce the changes to bank capital requirements that he’s been talking about.

So they should hold off for a month or so. But you should also expect the unexpected.

Greg Canavan+,
for Markets and Money

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Greg Canavan is a Contributing Editor at Markets & Money and Head of Research at Port Phillip Publishing. He advocates a counter-intuitive investment philosophy based on the old adage that ‘ignorance is bliss’. Greg says that investing in the ‘Information Age’ means you now have all the information you need. But is it really useful? Much of it is noise, and serves to confuse rather than inform investors. And, through the process of confirmation bias, you tend to sift the information that you agree with. As a result, you reinforce your biases. This gives you the impression that you know what is going on. But really, you don’t know. No one does. The world is far too complex to understand. When you accept this, your newfound ignorance becomes a formidable investment weapon. That’s because you’re not a slave to your emotions and biases. Greg puts this philosophy into action as the Editor of Crisis & Opportunity. He sees opportunities in crises. To find the opportunities, he uses a process called the ‘Fusion Method’, which combines charting analysis with more conventional valuation analysis. Charting is important because it contains no opinions or emotions. Combine that with traditional stock analysis, and you have a robust stock selection strategy. With Greg’s help, you can implement a long-term wealth-building strategy into your financial planning, be better prepared for the financial challenges ahead, and stop making the same mistakes that most private investors do every time they buy a stock. To find out more about Greg’s investing style and his financial worldview, take out a free subscription to Markets & Money here. And to discover more about Greg’s ‘ignorance is bliss’ investment strategy and the Fusion Method of investing, take out a 30-day trial to his value investing service Crisis & Opportunity here. Official websites and financial e-letters Greg writes for:

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