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Week Commencing June 30, 2014

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Quote of the week“My theory on life is that life is beautiful. Life doesn't change.

You have a day, and a night, and a month, and a year. We people change - we can be miserable or we can be happy. It's what you

make of your life.…”•Sheikh Mohammad Bin Rasheed

Al Maktoum

This week we look at the following topics: * Brent crude vulnerable at US$115We wrote about the important inflection point last week, a short update to current price action.* Questions and answers from last week’s webinarWe received many great questions from those that attended, our answers are attached.* Euro starting to stabilise, what to expect in new financial yearIt seems as though EURUSD1.3600 is holding for now, so what does this mean?

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Brent crude vulnerable at US$115

We published a short update on the Brent crude price on our Invast blog last week. If you aren’t reading the blog, make sure you start making it a habit. We have a whole range of contributors who add content on a daily basis.

This publication is more about the overall trading and investing plan, some bigger picture themes but our more immediate thoughts and daily insights are all on the blog. Both this report and the blog should be read together. You can read the exact blog post which we are referring to by clicking here.

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In last week’s post we said “…As I write, the Brent price is now just below US$115 per barrel which I think is a major inflection point. We either come down or massive up from here, make no mistake about it. I doubt that the Brent price will just sit and consolidate at US$115…”It seems as though the US$115 level has failed in the short term. We saw a large pullback from here. Make no mistake, we remain bullish about the medium to long term oil price but we don’t ignore the short term movements either. Brent has failed to rally above US$115 on what we consider to be fairly significant news in Iraq. It will most likely find support at around US$110 or thereabouts before resuming a higher move sometime later in this calendar year.

Image: Brent crude four hourly chart via Invast MT4 platform

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So in the short term, we can’t see any immediate catalyst to shock energy markets into a Brent buying frenzy. We will most likely see some hot money coming out of Brent and the serious long term and strategic traders starting to get in around the US$110 level, or thereabouts.

In the blog post we touched on something very important, data out from BP in their annual statistical review. Clients who have been reading Invast Insights since its inception in August last year know just how much value we put on the BP numbers. They are the single most important piece of data – in the form of a concise report – which many in energy markets use as their overall guide.

For those who missed the link, you can go directly to the report by clicking here. We like to make life simple for you. But make sure you read the rest of the report to find out why we think this year’s data is important. The BP numbers are great. They’re free, up to date and put together by a very well respected team or geologists at BP. Print it out and leave it on your desk. Every time you hear something on the news or media about oil, go to the statistics and judge for yourself just how important an even really is, based on statistical facts.

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The most important part of the report for us was the difference between oil production and consumption last year. Despite all the rhetoric in the media/news/analyst community about the United States becoming energy dependent and oil demand reducing, total global oil consumption grew by 1.4% compared to total global oil production which added only 0.6%. The 0.8% difference is huge when considering the fact that the oil market is already stretched and geopolitical events have not yet had an impact on oil production around the world. The key word here is yet.

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The other important element to consider is the impact of the Non-OECD countries on the overall pie. While the developed world consumed around 0.4% less oil in 2013 compared to the prior corresponding year, the developing world consumed 3.1% more and in 2013 Non-OECD countries for the first time ever represented a greater proportion of oil consumption that OECD nations. This is a gigantic shift.

Any benefits from less oil dependence and consumption in countries like the United States and continents like Europe is being completely evaporated by growth in developing nations. This is one of the main reasons we remain upbeat about Brent crude and energy prices over the medium term. Any short term weakness which as written above seems likely would be an opportunity to enter the market for medium term gains.

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Questions and answers from last week’s webinar

We held a very interesting webinar on 24 June 2014, providing an outlook on the Australian dollar for the new financial year. The webinar was not recorded, so make sure you register for all future Invast webinars to ensure you get in on all the action and have the ability to ask questions from our panel of expert presenters. The webinar was hosted by Peter Esho –Editor of Invast Insights and contributor to Invast publications.

Esho ran through the fundamental drivers behind the Australian dollar and explained why, based on statistics and current live economic indicators, the currency is likely to continue drifting lower against the US dollar over the next one to three years, settling somewhere in the mid 80 cent range where the Australian economy can cope. We received some great questions throughout the webinar and here are Peter’s concise answers to all of the questions asked.

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Was BHP due to expansion or general production?

I explained that the impact from lower iron ore prices is yet to flow through into the economy. I spoke about BHP as an example, shedding jobs in Western Australia. The decision was directly related to lower iron ore prices and different to job losses in Queensland where they predominantly mine coal.

Gold and oil are something of a mystery, any comments?

Sure, it’s something we have been speaking about on WEEKLY basis in Invast Insights. Make sure you are getting all our reports, if not speak to an Invast staff. Better for you to read the reports and get a complete, thorough grip on our view.

What about the increase in gas exports?

Rising gas exports will start to have a larger impact on Australia’s exports, this is true and a great point. Iron ore has been our largest export but who knows, if all the gas projects go ahead according to plan and energy prices hold up, gas could become our largest export.

The problem here though is that once the gas projects have been developed, they require very minimal employment needs and so the impact on GDP growth will be minimal. So not so much an issue about national income here, more about multiplier effect on GDP growth prospects.

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Are US housing starts not related to the baby boomers retiring?

Perhaps, but there are always if’s and but’s when it comes to economic data. The United States is vast and large enough to support a million or two housing starts every month considering migration, birth rates and the fact that it is still coming out of a large downturn. Baby boomers have children, they in turn have children etc. it’s not as though the baby boomers are a once in a lifetime anomaly, they are statistically significant but we can’t discard all the other data too.

When will it flow through into the trade figures?

I presume the question here is on iron ore, we think the next few quarters of GDP and trade numbers will start to show the full impact of the huge decline in iron ore prices.

Where are you predicting the Aussie dollar will be in 12 months?

Based on the presentation material, I would be forecasting something closer to 85 cents against the US dollar over the next one to three years. I don’t provide exact, precise short term targets because this is extremely difficult.

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Why is Morgan Stanley predicting parity?

Not sure to be honest, we don’t really read other analysts research. We focus on our own way of thinking and put together our own arguments. If we were to look at all the investment banks and take into consideration all their forecasts, we would never get anything right! We don’t think the Australian economy can cope with parity, we are still feeling the impact of the currency trading above parity over the last few years. We respect all other organisations but don’t necessarily agree with any of them.

With the significant drop in the iron ore price in the last 2 months, how is this likely to impact on terms of trade and the Aussie dollar?

We’ve explained this above somewhat.

Do you have a ST outlook on the AUDUSD?

For a short term view, make sure you are signed up as a client and receiving Vito Henjoto’s daily analysis. He is one of the best technical analysts I know in the market and has excellent analysis on a short term basis through his technical indicators.

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If China's growth is key to the AUD’s rise or fall, then a long term view would still see a sustained growth rate of at least 7% for a long time to come, so doesn't this support the rise of the AUD despite the view of mining slowing down?

True, but the presentation was in the context of the AUD against the USD, so what happens in the USA and its economy is perhaps even more important than what happens to Australia and China. It’s a two way relationship.

Will this session be recorded?

Unfortunately not, so make sure you do your absolute best to attend all future Invast webinars.

Hi Peter, I think the charts you share is NOT continuing, it seems you need fresh sharing function all the time, otherwise, we can NOT see charts in time.

Sorry folks, we had a bit of an issue with some of the charts freezing in the webinar, we will make sure this doesn’t happen next time.

Euro starting to stabilise, what to expect in new financial year

We’ve been negative on the Euro for a while. When the Euro was trading just below 1.40 against the US dollar we wrote several pieces in this publication and the Invast blog about a good short position opportunity and the fact that Mario Draghi would have to act in order to ensure credibility behind the ECB. That happened exactly as we had expected.

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In mid-April we wrote “Without getting ideological, our point here is that ECB Governor Mario Draghi has been cautioning the market now for the past few months that the recent rally in the Euro is uncomfortable and the pace of the European economic recovery is not strong enough. When will it happen? I’m not entirely sure but I do know that it has to happen.

The market has been sitting on the sidelines, waiting for Draghi to move. So far no move but Draghi knows very well that his talk can only last for so long. Eventually, he needs to play his hand otherwise the market will call his bluff. It’s about probabilities. The last thing European exports need is an ongoing elevation in their currency relative to peers.” You can read the blog post here. Our call was to short the EURUSD.

When Draghi did finally move, we said “We think this ECB move is the roll of the last dice. There won’t be any second chances following Draghi’s June action. There is a growing sense of fear among many in the market that the fragile structure of Europe and the inability of governments to reduce unemployment towards levels seen in the UK and USA might lead to an all-out flight away from the Euro as a currency and the flow on effects of rising government bond yields.

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If there is anything that keeps us up at night it is the prospect of European sovereign debt issues returning to the market again. This time the impact will be worse because the ECB’s debt burden and the member state’s balance sheets have been put to use several times in order to get to where we are. ” You can read the full note here.

Image: Brent crude four hourly chart via Invast MT4 platform

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The point of pasting these two sections is to provide some context into how we have been thinking about the Euro. We do see danger around the strategy, but for the time being we think the EURUSD has found some reasonably solid support at around the 1.3600 level. We think this might take some short term momentum out of the DAX and other European indices which have been major beneficiaries of the Euro’s decline.

The Euro needs to continue falling for these major stock markets to keep rallying, we think the Euro will continue to decline over the next year or two but that decline might be halted for a couple of months as some type of stability comes in. any elevation above the 1.3700’ish level will be met with more panic at the ECB. Draghi wants a lower currency, he has a mandate from European multinationals who have lobbied their governments. So for now, a bit of a breather on the Euro decline and perhaps a good time to lock in some short term trading profits before the next storm emerges.

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