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Oil Up On Bailout Hopes

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Crude prices were slightly higher on Sunday night on hopes the $700 billion government bailout would end the credit crisis and demand would resume. I think that is a stretch but it is still the reason being given in Asia for the rise.

The rise is even more confusing since the MEND rebels in Nigeria called a truce in the war against the oil companies. The MEND rebels said the truce was in response to a plea by tribal leaders to halt the violence and the truce would stand unless the Nigeria military attacked a MEND base camp. It was only last week that the MEND rebels declared an all out war after a major battle with the military. I don't have a lot of faith in the truce since they call one about once a month and they always get broken. Still they are always good for a move in oil prices. That is why the rise Sunday night is confusing since a truce should be a sell signal.

I believe the real reason is the falling dollar. The dollar was crushed for about 300 basis points last week and with the $700 billion bailout in the wings it is probably going lower. The flight to quality was so strong last week that the yield on U.S. treasuries actually went negative for a brief period. That means you would essentially be paying the government to hold your money. Obviously that was an anomaly brought on by an enormous surge of buying and not a condition that would last for more than a few minutes.

However, we learned on Sunday that the last two U.S. investment banks are changing stripes. Morgan Stanley and Goldman Sachs asked the Fed for permission to change to bank holding companies so they could create commercial banks and accept deposits. This application was quickly approved and will take effect after a 5-day waiting period. This will enable the companies to borrow money from the Fed for longer terms using various amounts of collateral. By accepting deposits it also puts them in a stronger position to weather future financial storms. Funds in deposit accounts are available for use by the bank. It is the cheapest source of financing a bank can have. This change should provide more comfort to the financial system even though this is a long-term change that will take years to implement in any meaningful amount for anything other than loans from the Fed.

Another reason for the rise in oil is the appearance of another tropical storm now hitting Puerto Rico that could turn into a named storm (Kyle) at any time. The storm is moving westward at a pace that would put it in the gulf in about 3-4 days. If it does begin the process of turning into a hurricane the gulf oil facilities would immediately have to cease repairs and begin evacuations again. Most are not yet back to full strength and it is projected to be weeks before production returns to normal. Another storm now would be very damaging to crude oil and gasoline inventory rebuilding efforts.

Another factor impacting the price of crude Sunday night is the pending expiration of October crude futures at the close on Monday. Any trading positions have to be closed and moved into future months.

Jim Brown  


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