Markets lower on Friday night, Saudis winning the war against US oil, ASX futures down 28 points

Bearish traders are having another go at rattling equity markets, with most of Europe down around 2.5% and the US down 1.5% on Friday. As traders begin to conduct a post-mortem on the August sell-off, it will be important not to jump the gun in thinking that the worst is behind us. We still have a key intra-day level of 4,733 on the ASX 200 futures market to focus on remaining above in order to experience cushioning from another fierce sell-off; however, when you look at today's first chart that shows the Aussie dollar (blue), US S&P 500 (orange) and the ASX 200 (black), it's clear that we in a down-trend. Australian shares are under-performing those of the the US, when we use a 31 July starting line, likely reflecting a softer earnings season locally, relative to the US.

Last week I read some commentary out of the US that leads me to believe that--fundamental global growth issues aside--the magnitude and velocity of the short-term volatility that we've been experiencing is largely the result of US algorithmic trading models that became highly-correlated in their positioning of the S&P 500 market, as it spent six months trading in a tight range with a lower boundary of around 2,040. As soon as that level was breached, I have no doubt that systematic trading models were all queued up to stop out of long positions that would have otherwise been built up on the assumption that the range-bound swings in trading would continue. While it would have been perfectly reasonable to see US equity markets re-rated a little lower due to elevated price-to-earnings ratios, the emergence of high levels of volatility is exacerbated these days because so much indiscriminate selling takes place on the back of these mathematical trading models.

To a different topic and the Financial Times ran a piece over the weekend focusing on the gap between the capital expenditure and revenues from US companies that extract oil from oil shale, a sedimentary rock that is abundant in North America, and is also quite plentiful in Australia. When crude prices mysteriously fell below US$100 in July 2014, the headlines speculated that many things were to blame, and it came at a time when geopolitical issues were hot - the Russian stand-off over flight MH 17, ISIS advances, and supply coming back online from Libyan refineries. But as the falling price snowballed, OPEC made it known that it had no intention to intervene by restricting supply from its largest producer, Saudi Arabia. As time went on, it became clearer that the Saudis were not rejoicing alongside the US government as it became increasingly energy independent, which resulted from US$100 per barrel oil prices funding the expensive extraction of crude oil from oil shale - imports of oil to the US were plummeting.

Prices fell from US$100 to below US$50 in six months, and every time they've looked like recovering, the market has fallen away again and WTI's 200-day moving average is almost down to US$50 per barrel, which is exactly where it needs to be to put the small, fragmented network of oil shale producers out of business. The FT reports that "US independent oil and gas companies exceeded their cash from operations by about $32bn in the six months to June, approaching the deficit of $37.7bn reported for the whole of 2014." With a currency pegged to the US dollar, which has risen in strength by 20% since July 2014, Saudi Arabia is not keen to see oil prices remain low forever, and it is in financial pain because of this rout; however, it needs to sufficiently demonstrate that it is willing to do what it takes to maintain relevance in a world where clean energy technology and alternative fossil fuel reserves are competing against its product. It is true that OPEC is not solely to blame for the falling oil price - global demand never recovered since the GFC. But as the FT highlights, financing for major oil exploration and production out of the US is falling, which could be the signs of long-term adjustment that the Saudis have been looking for.


Source: Rivkin, Saxo Bank

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This article was written by Scott Schuberg, CEO of Rivkin Securities Pty Ltd. Enquiries can be made via info@rivkin.com.au or by phoning +612 8302 3600.

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