Saudis Pump All Out as the Global Economy Crumbles

It is a mindless philosophy that assumes that one’s private beliefs have nothing to do with public office. Does it make sense to entrust those who are  immoral in private with the power to determine the nation’s moral issues and, indeed, its destiny? …. The duplicitous soul of a leader can only make a nation more sophisticated in evil.
– Dr. Ravi Zacharias

 A reasonable action on the part of the majority is very rare, while the evidence of mob stupidity and brutality is overwhelming. The majority in power make laws for their own financial benefit, disregarding the interests of the minority, and when the weak minority, by adding to its numbers, becomes powerful, it, in turn, does the same thing; thus, by appealing to power to settle their conflicting interests, the conflict would go on forever.
– Charles T. Sprading

A little government and a little luck are necessary in life, but only a fool trusts either of them.
– P. J. O’Rourke

Saudis Pump All Out as the Global Economy Crumbles
In an election year where The Bernank is afraid to print more money despite his understanding that he must in order to keep the ponzi going (if only for a few more months), Obama has been given a gift by the Saudis in the form of purposefully flooding the world with oil.  Specifically, the Saudis are now pumping 9.9 million b/d, which is the highest level in at least the last 20 years (see chart below).  This increase in output has come at the exact same time that much of Europe has fallen into depression and as China and many of the BRICS have collapsed from higher than average growth rates to what I believe is barely positive real GDP growth (if we actually had reliable data).  This oversupply of crude has led to a severe correction.

I think the realization of the situation in Europe and the emerging markets accounted for the initial 10% or so drop in Brent crude from $125/b to $110/b.  The most recent 10% plunge to just below $100/b as of today can, in my opinion, be explained by the sudden understanding that the U.S. is not the Goliath the presstitutes in the mainstream media would have you believe.  Rather, as I mentioned in my email from last week, I believe that May represented the tipping point into contraction for the domestic economy.  A process that could unfold a lot faster than most anticipate.

Saudi Crude Oil Production 1982-Present

As you can see from the above chart, Saudi oil production is at its highs.  The fact that they continue to flood the market is no accident.  It is a favor to Barack Obama and the United States generally.  The idea was that if oil supply flooded the market and knocked down the most important commodity in the world, this would serve as a hidden “stimulus” in an election year.  It would represent something of a tax break to the American consumer and thus make things look better into November.  That was the plan.  Unfortunately for them, it is not working.

The reason it is not working is because we do not have a healthy global economy.  We have a giant house of cards built on debt and derivatives, which market forces desperately wants to blow away so that the system can reset.  The ponzi has gotten so gigantic at this point that a little extra Saudi oil isn’t going to do the trick.  As I have been saying for a while and made clear last week, when the forces of nature start to roll over again there will be no stopping the train wreck.  It will be so catastrophic and overwhelming that asset prices will do things pretty much no money manager out there is anticipating at this point.  While The Bernank and his minions can go out in public and lie about the state of the economy and claim they do not need more QE, the only thing they are doing is setting the stage for a seismic price readjustment in assets classes globally.  It is a readjustment they will not be able to accept, and the global Central Planner response will have to be so massive just to keep things together it will send gold to at least $2,500/oz.

The other thing I would point out is look at where Saudi production was in the summer of 2008.  It was at a high of 9.6 million b/d right before the entire global financial system melted down.  Is history repeating itself in crude?  If so, what is the downside?  My sense is the downside is much, much higher than in 2008.  Back then Brent crude got to just below $40/b.  There are many reasons for this, but I think one of them relates to the fact that there was a commodity bubble going into the decline at that time.  Not so in 2012.  Furthermore, the marginal cost of oil has only been moving higher and higher as conventional supplies have peaked and the world is relying more on higher cost shale, deepwater and oil sands.  My guess is that even if the global economy goes into a depression like state, I do not think oil will sustain itself much below $70/b.  In fact, my guess would be somewhere in the $60s/b will be the low and that will only happen if the Central Planners play things too cute and do not act until this fall.

The last point I want to make is that commodities are way ahead of stocks in the U.S., and the sell-off in equities we have seen so far may have quite a bit more to go.  The dominoes this time are falling in reverse to what happened in 2008.  Back then, it was the U.S. that cratered first and later commodities joined the show.  There were dreams of BRIC decoupling in the air.  This time Europe and the BRICS went first and there are new dreams of decoupling – this time centered upon the U.S. economy.  This dream, like the prior one, will turn out to be a nightmare.  Brent crude has already corrected by about 24% from the highs.  The Dow Jones Industrial Average is only down 8% from the highs.  24% would put it at about 10,000.  Decoupling didn’t exist in 2008 and it doesn’t exist now.  Plan accordingly.

Peace and wisdom,

Mike

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