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Oil Slick

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Crude oil printed new record highs today, and a weaker than usual showing from indirect bidders at the Treasury auctions saw bond yields rise. Equities continued their slide from Wednesday on the light volume that has characterized this summer's trading.

Volatility rose, but not by much, and volume breadth was lightly negative (-1.41:1 on the NYSE and -1.72:1 on the Nasdaq) as equities retraced another chunk of the rally, turning the clock back to the latter half of July. With a solid slate of market moving data scheduled for tomorrow, including an FOMC announcement, the most surprising thing about today's trading was not the weak volume or ambiguous internals, but rather the fact that it produced an unambiguously directional move. That's not to say that today's light volume losses might not be reversed tomorrow, but in the meantime, the price action was decisive where the secondary measures were not.

Daily Dow Chart

The Dow lost 21 point to close at 10536, bouncing from a lower low of 10524.91. The morning bounce failed below Friday's high, and the daily cycle downphase crossed the midpoint of its range. 20-day Bollinger support is at 10514, below which is confluence support at the 10440-50 level. Bulls need a close back above 10630-40 to stall the downphase, but in the meantime, and as the weekly cycle downphase (not shown) gets underway, the benefit of the doubt goes to the bears.

Daily S&P 500 Chart

The SOX logged its third day of lower lows and lows lower highs, failing below 1232 and rising less than a point off its low to close at 1223.13, -3.29 for the day. 1218 support is in view below today's low, lining up with confluence support from June and July, as well as the bottom of the 20-day Bollinger channel. As with the Dow, the synchronous daily and weekly downphases favor more downside from here, but longer cycle tops are less certain than those in shorter timeframes. A return to test or even briefly exceed the current August high would change nothing in those longer timeframes- only a strong upside break on a weekly basis close would suggest a more bullish trending move.

Daily Nasdaq Chart

The Nasdaq got clipped for a 13.52 loss to close at 2164, also less than a point from its low and outperforming its peers to the downside. The decline since last Wednesday's close fits well with a bear wedge interpretation, which in this case would imply a target as low as 2050. The daily cycle downphase is less far along than that of the Dow, and 20 day Bollinger support is at 2134. Below 2200, the bears should continue to press. While an intraday corrective upphase is overdue, the market had a "heavy" feel again today, with the bounces flaggy and short.

Daily TNX Chart

Bonds were weaker today as well. UPI reported ominously that Saudi Arabia will be seeking to repatriate $360 billion "invested abroad" during the past year and a half. Foreign Minister Price Saud al-Faisal seeks to return these Saudi funds in the hope of attracting foreign investment, characterizing the money as "national assets".

This follows the theme expressed in recent weeks and months by Asian central banks seeking to diversify their investments away from US assets. As seen in CNOOC's attempted acquisition of Unocal, foreign countries may be losing their appetite for a US-treasury-only diet. However, if they're blocked from spending those US dollars on other US-dollar-denominated assets, (such as Unocal) then the risk is that they may seek to acquire other currencies in exchange for their production, be it consumer items, petroleum products, automobiles or labor. Bonds were weak following the Saudi announcement, but it received next to no coverage in the financial press and probably had little to do with today's rise in yields.

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The Treasury auctioned $52 billion of debt today, via 13-week and 26-week bills, and 3-year notes. $18 billion of 13-week bills generated a bid-to-cover ratio of 2.09, with a high-rate of 3.46%. The 26-week bills generated 2.07 bids for each accepted, a high-rate of 3.68%. These were the highest rates for the year, and while my data is only quarterly before January 2005, these appear to be the highest rates since 2000. Indirect bidders (foreign central banks) purchased $7.4 billion of the total.

On the 3-year notes, the bid-to-cover ratio was 2.31, the high-yield 4.204%, also a new high for the year. Foreign central banks were bigger buyers of this longer-dated debt, purchasing $5 billion of the total, but that 28% participation rate was well below the 40.3% it purchased at the May auction and the 45.6% it averaged in 2004. 3-year notes were not issued between 1998-2003, but today's high-rate easily broke the previous high at 3.821%- the next highest level was set in 1998, at 5.524%. The combination of high-yield and weaker foreign demand was obviously not bullish for treasuries overall.

Ten year notes were under pressure all day, only briefly dipping into positive territory in the morning, but the strong surge in crude oil (see below) made a 4.40% yield look less substantial than it did last week. Ten year note yields closed higher by 2.7 bps for the day at 4.419%, breaking the key 4.4% resistance level which now becomes support. Next resistance is at 4.44%.

Fannie Mae (FNM) announced that US home prices rose at an annualized rate of 16.5% in Q2, up 14.1% from Q2 2004. This shows upside acceleration, with Q1's annualized rate 12.5%. FNM stated that it sees no sign of slowdown, with Marketwatch quoting FNM's chief economist David Berson as saying that price gains in the middle of the country "were relatively normal" compared with the 20%+ gains in the Pacific, Southwest and Mountain regions.

Daily Chart of Crude oil

Over the weekend, supply fears were renewed by news of a tropical depression threatening the Gulf of Mexico as well as the closing of US embassies in Saudi Arabia today and tomorrow due to terrorist threats. This morning, crude oil opened higher and set a new record (in 2005 dollars). Traders opened their screens to see Sept. crude testing the 63 level. Reuters reported that two years of "unexpectedly strong demand for gasoline" have US refineries struggling to satisfy demand "after a decade of underinvestment." This supply-demand gap has been exacerbated by several unplanned refinery outages during the past few weeks, ConocoPhillips and Valero's being the most recent, and this at the peak of the US easy-motoring season.

Compounding the problem is a widespread, "say it to the hand" denial of the problem. Ever-more powerful and consumptive vehicles are still be produced and promoted by the automakers. Petroleum, of finite and ever-dwindling supply, remains the global energy source of choice, with woefully little progress having been made to date in the development of viable alternatives to power the Western world's, and particularly North America's current lifestyle and expectations. Potentially huge demand from China and India has yet to assert itself, but increasing industrial and economic prosperity in those regions make such development likely if not inevitable. Add in the fact North America's greatest suppliers of the lightest, sweetest oil are in parts of the world that are currently "hot" and not particularly sympathetic to North America's aspirations, as well as the usual environmental and logistic factors that can and routinely do threaten vulnerable infrastructure, and the picture is as bullish for oil as can be.

President Bush signed the energy bill into law today, characterizing the Act as a "critical first step" while conceding that it offered little in the way of short term relief for high prices. The law is said to boost US nuclear power, oil drilling, encourage the conversion of coal into cleaner energy and boost biofuels such as ethanol. Critics noted the Act's wide-ranging assistance and incentives for energy companies already enjoying record profits. Reuters quoted Anna Aurilio, legislative director of the US Public Interest Research Group, saying that "Big energy lobbyists may be cheering the bill's enactment, but ordinary Americans had better hold fast to their wallets. As gasoline prices careen out of control, the bill keeps America speeding down the wrong road toward more oil consumption, more drilling, and more pollution."

Against this backdrop for crude oil prices is the impressive gain already recorded during the past few years. While bearish arguments for the price of oil can be easily refuted on the facts, on a technical basis it's possible that the price has gotten ahead of itself in the shorter term. Bullish traders will continue to buy the dips at support, secondary support in the 59 area and the primary daily trendline at 53. Note the rising triangle on the daily chart below the 62.50-63 area, broken today on the upward surge. Sept. crude futures printed a high at 63.95, pulled back and ran back to touch 63.975 in the 2 minutes before the afternoon close at 63.90, +1.60 or 2.57% for the day.

In corporate news, Alcan (AL) announced earnings which declined from $285 million or 77 cents to $208 million or 56 cents in the current quarter. These were earnings from continuing operations, net of derivative and foreign currency factors. Sales declined from $6.21 billion in Q2 2004 to $5.21 billion this quarter, exceeding estimates by $300 million. On EPS, estimates were for earnings of 61 cents. AL rose 2.17% to close at 33.89, off an intraday high of 34.82 printed in the morning.

Energy company El Paso (EP) reported a Q2 loss of $246 million or 38 cents, down from a $5 million or 1 cent profit in Q2 2004 on revenue which fell 20% from $1.52 billion to $1.22 billion during the period. Analysts were expecting a profit of 13 cents. The cherry on top (for bears) was an SEC request for information relating to its oil-for-food program in Iraq. This was the second SEC request since November 2004, when the SEC inquired about its acquisition of Coastal Corp. EP lost 2.12% to close at 12.03.

Auto parts makers were hurting as they reported earnings for the quarter. Delphi (DPH) got slammed for more than 14% in premarket trading as it reported a net loss of $338 million or 60 cents per share, down from a profit of $143 million or 25 cents in the year-ago quarter. The company warned that bankruptcy is possible, and cited lower demand as a result of waning production from GM, high raw-material costs and obligations for pension and health care benefits. The company's non-GM business outside the United States performed well. While the hyenas were tearing into DPH, Visteon (VC), which was spun off from F in 2000, warned of an expected $1.2 billion or $9.49 per share loss but noted that sales to customers other than Ford rose 29% in the current quarter. In DPH's case, the loss was attributed to production cuts from GM. DPH rose 2.42% to close at 5.08, while VC rose 15.63% to close at 9.84. GM closed lower by .63% at 34.97, while F closed unchanged at 10.36.

Tomorrow is scheduled to be a doozy of day, with the preliminary Productivity report for Q2 and Wholesale Inventories for June in the morning and the FOMC policy announcement in the afternoon, followed by Cisco's quarterly report. In recent announcements, we've seen a relatively muted response to the Fed's announcement. A 25 bp increase is widely expected, and participants will be paying closer attention to the accompanying policy statement. On the one hand, the Fed's been consistently denying inflation-risk, particularly net of "volatile food and energy prices." On the other hand, rallies in the price of energy, food, real estate, healthcare and virtually everything else that people need in the ordinary course of their lives indicate differently. If the Fed is too easy, those rallies will be more likely to gain strength. If the Fed is too tight, so the argument goes, those rallies will be pressured, as will the credit bubble and the many markets it supports. Boil this dilemma down to the hundreds of millions of trading decisions being made in the currency, treasury, commodity and equity markets in the minutes and hours following the FOMC announcement, and you have the makings of a choppy, treacherous tape. Be careful, and as Jim says, enter passive, exit aggressively.
 

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