Marching to the beat of the (oil) drum

The big overnight move was in oil which rallied close to 5% on the back of rising tensions in Iran – and a military build up by the US in the Strait of Hormuz – along with stronger factory orders in the US. An army general in Iran was reported as saying the country wouldn’t “sit idly” by as the U.S. and Europe built a missile-defence shield program that could target Iran. Iranian authorities staged missile drills late Monday to test weapons reportedly capable of hitting targets as far away as Israel and announced possible legislation aimed at closing the Strait of Hormuz. US and European embargoes on Iranian oil also recently took effect. 

I am still of the view that America is unlikely to take any military action before the presidential election at the end of year, and that Obama will be content to sit back for the next 6 months and see if the sanctions take effect. I think the sanctions will have little chance of succeeding, and given the turmoil in Syria – and the escalating prospects of a full blown civil war, Iran’s leaders are pursuing their nuclear program out of fear and “motivation for self preservation”. 

Next year the conflict is however likely to escalate in my view, and America will likely throw its full weight behind Israel and use the military option to defuse Iran’s nuclear option. From Israel’s perspective, “self preservation is also a powerful motivation”. In terms of the oil price, there is danger of a price spike next year, which could then act as headwind for the global economy. For now though, I think energy is recovering from the extremely oversold levels during the “risk off” correction and we are now seeing this trade unwind. 

On the daily chart below, oil has successfully broken up from a short term downtrend after encountering very strong longer term support around $80 barrel. 

The longer term trend for oil is bullish in my view and as we can see on the chart below, the price has rallied after bouncing off a key support level. For the next six months however, I don’t see higher oil prices going much above $90 and therefore not a negative for the global economy. Geopolitics is however likely to be back on the table next year as a risk factor for markets. 

Energy stocks remain attractively priced at present and our analysts continue to favour industry heavyweights such as Oil Search, Woodside, Royal Dutch Shell and BP. BHP also can be included with around 30% of NPAT derived from the energy sector. 

BP’s chart structure is constructively bullish and after clearing overhead resistance at 430, we should see further appreciation over the next 6 months. Energy stocks are undoubtedly cheap globally. 

The other catalyst for the energy price rallying along with gold is growing expectations of further stimulus measures to be announced at respective meetings of the Bank of England and European Central Bank this Thursday. Rumour suggests that ECB President Mario Draghi might be encouraged by the success of last Friday’s announcement and do more than just cut rates; while the BoE is expected to ramp up its asset purchase programme. 

Gold looks interesting at current levels, and last night’s upward dynamic is bullish. We can expect the overhead resistance level to be tested near term, and a breakout to the upside would be bullish. 

I believe gold stocks (which have been horribly depressed for the past 18 months) could now undergo a catch up rally if prices can sustain higher levels above $1640. We need to watch this space closely. The other wild card of course is the Federal Reserve which has so far kept its powder dry, but with the labour market struggling in the US, the prospects of a near term move are increasing. 

Turning back to equities and the follow through rally overnight, stock markets clearly approve of the fact that banks can now be recapitalised directly following last weekends summit, and appear to now believe the EU leadership is finally on the right track. 

The FTSE closed up 47.09 or 0.83% to close at 5,687.73, while the CAC and DAX added 0.96% and 1.26% respectively. The S&P500, Dow and NASDAQ managed to extend Friday’s gains and rally between half and 1 percent. 

Whilst trading on Wall Street was subdued on thin volume due to a half-trading day ahead of tomorrow’s Independence Day holiday, the advance adds weight to the sustainability of Friday’s upward dynamic. US equities were also buoyed by news that May Factory orders rose three times more than forecast, spawning hope that US manufacturers might be less vulnerable to events in Europe than feared. New orders for manufactured goods rose by 0.7% compared with the 0.2% forecast, following three successive months of falls. 

Over at the IMF Christine Lagarde continues to tow the cautious line lowering growth forecasts for the US to 2% this year and 2.25% next year, due largely to the European debt crisis. This compares with the IMFs most recent projections of 2.1% and 2.4% respectively. 

Wall Street appears to be marching to the beat of a similar drum to Europe amid renewed speculation of further QE – which really picked up following yesterday’s awful ISM manufacturing data. Stock markets are now pricing in the increased probability of co-ordinated global central bank action. China is also likely to cut its bank reserve ratio requirement to boost liquidity. 

Important jobs data is due after Wall Street’s return from July 4th celebrations – including Friday’s non-farm payroll number – which, if nasty, could be the catalyst for the Fed to finally pull the trigger.