Crash Or Correction? SocGen Answers

by Tyler Durden
05/07/2011 17:00 -0400
56 comments

Following last week's crude drubbing brought about by correlations gone wild, following the 5 sequential margin hike-inspired collapse in silver, many are wondering if the silver correction is over, or if the crash is just starting. Here is Soc Gen joining in a very schizophrenic Goldman (a month ago: sell; yesterday: buy) telling clients the coast may be clear now that all the weakest hands have been purged (following SLV 88% share turnover on Thursday any latent mania elements have been exorcised).

From SocGen:

Oil prices experienced a huge sell-off this week, plunging by $12 /b on Thursday (11% over the week). Other energy prices followed but the extent of the move was much less limited (between –0.6% and -3.5% over the week). This can be explained by a number of reasons – most of all it seems market participants were finally convinced by the economic newsflow that downside risk have become dominant and it was time to take profit. The question now is obviously if - after the usual technical rebound - this will continue next week and translate into a crash, energy markets in Europe following oil with a lag. Or if prices will stabilize close to present levels, in what should then be considered as the correction of excesses. Our view is that the correction, a violent one, could be over as overall fundamentals remain sound. Hence some prices will stabilize (coal and power), at least temporarily. Further drop for gas is however expected, coming from the continuing seasonal adjustment for which gas is late as compared to the other components of the power complex. Carbon should suffer from this gas movement, with limited downside risk.

Full note:



Energy prices collapsed this week. Brent month ahead contract dropped by a staggering 11%, moving from $125.89 /b to 112 /b, of which almost $12 /b in a single session (Thursday), a rare fact. Following this dynamics but with a much lower amplitude, gas prices (NBP month ahead) lost £p2 /th and closed on Friday at £p55.8 /th (-3.5%). For coal, power and carbon prices, the pattern was slightly different. They started the week with an increase. German baseload Cal12 and CIF ARA Cal12 reached €59.82 /MWh and $133.25 /t respectively on Monday and Tuesday, continuing on previous week’s momentum. Then they followed the oil prices and strongly retraced from Wednesday to Friday. On the whole, German baseload Cal12 and CIF ARA Cal12 lost €0.9 /MWh and $3.75 /t, closing today at €58.2 /MWh and $129 /t. For carbon, the early week increase was strong with Dec11 EUA closing on a new high €17.42 /t on Monday, at a level not seen since November 2008. The contract fell only by 0.6% over the week and finished
today at €17.04 /t.

So the energy markets brutally turned eventually. This comes after two quiet weeks marked by long breaks and holidays across Europe, delaying decisions – which might partly explain the brutality. Last week had finished on a rather bullish note, encouraging our view for this week that prices would still hold to high levels, and even increase for some of them (coal in particular). Fundamentals indeed had turned more supportive for prices, but sentiment made it all in the last four days.

What happened? The market had become nervous over the recent weeks on concerns that the emerging countries would see their growth reduced in H211 due to the difficult fight against inflation, which is leading some of them to tighten their monetary policy. China has been in a tightening cycle for months – without much success on inflation readings so far. When India surprised this week by raising interest rates by 50 bps instead of the expected 25 bps, the concerns heightened. As the most liquid commodities (oil, precious metals) have largely become a macroeconomic play, and an EM play in particular, these concerns had lead investors to consider commodities as increasingly risky assets, whose potential for appreciation had turned quite limited in the short run. The good Q1 corporate results in the US and in Europe, very often beating analysts’ expectations, had temporarily appeased these fears as they sent equity indices up to levels unseen since mid-2008 (for the US stocks at least). The enthusiasm over, operators have started to take into consideration the bad news again. And realized the dark cloud has been getting darker and bigger over the recent weeks.

Western economies remain fragile. In Europe the lingering risk of the sovereign debt crisis is in the news again, through the Portugal bailout and the talks of Greek debt restructuring. In the US, the debt rating downgrade is still in the memories and the end of QE2 in June leaves the market wonder if this means the end of ever more cheap liquidity around, hence the end of the golden period for risky assets. The rising topic of oil demand destruction due to high prices, the bad unemployment figures yesterday in the US (jobless claims increased to an 8-month high while they were widely expected to drop) and the bad German factory order figures exacerbated the worries on the state of the developed economies.

At the same time the threat of inflation is also getting more precise in the US and Europe, which eventually is no good for growth either, as it will lead to rate hikes. For oil, the bearish inventory report mid-week (see our US Petroleum Report dated 4 May) showing unusual stock builds even as the Driving Season is coming near, combined to news OPEC was considering raising formal output limits when it meets in June, pushed in the same direction.

Much has been made about the impact of Bin Laden’s death. While it might reduce terrorist risk, it is not completely clear why this would lead to lower risk of oil cuts in the Middle East – for this, the less commented demise of one of the Libyan leader’s son over the same week-end could actually bear more impact. The big “Abbottabad newsâ€