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Global Crisis Crushes Oil Prices

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The worsening global financial crisis caused oil prices to fall to $82 as fears of slowing demand suggested a surplus in production. OPEC was quick to warn that an emergency production cut would be coming in November but prices failed to respond.

The global market crisis worsened on Thursday with the Dow dropping another 678 points. On Friday morning Asia collapsed with the Japan Nikkei losing more than 10%. The drop was accelerated when Yamato Life Insurance filed for bankruptcy in Japan. Hong Kong's Hang Seng index fell more than 7% with Singapore's Straits Times index off more than 6%. The Australian ASX200 fell -8.34% and it's biggest one day percentage loss ever. The Indonesian markets were frozen indefinitely on Friday to "avoid deeper panic" stemming from the financial crisis.

The forced liquidation of mutual funds and hedge funds continued with heavy selling into the close. Declining volume was 13:1 over advancing volume. Nearly 14 billion shares were traded across all U.S. markets. Analysts are saying Friday could be really ugly ahead of the bank holiday on Monday. With banks only lending overnight the potential for a 3-day weekend could cause them to tighten cash flow even further. After the close ratings agencies warned they might cut the rating on Morgan Stanley and that came after 25% drop in the stock on Thursday.

On Friday there will be a $400 billion auction to determine a price in Lehman credit default swaps. With Lehman bonds trading in at 12-13 cents on the dollar the holders of Lehman bonds are going to be wiped out. If they bought insurance in the form of a CDS they can recover the lost principle from whoever sold the insurance assuming they still exist. This will be the largest CDS auction ever and the prospect of a complete disaster is weighing on the global credit markets.

Add in a downgrade on GM on Thursday that caused more than a 30% drop in the stock and the red ink continues to flow. The price of GM stock and the price of GM credit default swaps is apparently pointing to a GM bankruptcy. The rest of the auto sector is doing no better with auto loans almost impossible to get in today's market. If high gasoline prices were not bad enough the dealers can't even sell a car to a willing buyer if that buyer needs financing.

The price of energy stocks continues to fall along with the price of oil. It is not specifically because of the oil price drop because $85 oil is still a windfall for most energy companies. Chevron said on Friday morning that earnings in Q3 would be better than expected despite the drop in oil prices. Chevron (CVX) lost $9.10 to $64 on Thursday. Obviously there is no fundamental reason for the drop. Exxon (XOM) lost $9 or 12% to close at $68. Exxon has $38 billion in cash and short-term receivables and earns $11 billion a quarter. They will continue to earn over $10 billion even with crude at $85. There is no fundamental reason for the sell off in these companies.

The sell off in energy continues only because that is the only stocks with value that funds can sell to raise cash. Nearly every other sector is at 52-week or multi-year lows and the weakest sectors have been sold out. There is nothing left but energy and big tech to sell to raise cash.

Funds need to raise large quantities of cash right now. TrimTabs said funds saw withdrawals of $72 billion in September. That was a record for withdrawals. However, in the first week of October they saw another $50 billion in outflows. $43 billion in equity funds and $7 billion from bond funds. They have to raise cash by selling anything they still own that has a value. The losers were sold long ago. The mediocre stocks were sold next and now they are dumping anything left in hopes of remaining liquid through year-end.


The various market reporters are blaming the drop in oil prices on potential demand destruction from the global crisis. I agree there will be some decline but the majority of the worlds mobile population will continue to drive to work, drive for business and drive for shopping. If they were doing it two weeks ago they will still be doing it two months from now. Losing a million barrels per day of consumption or even 1.5 mbpd is not the end of the energy society. It just means that gasoline will be cheaper and we all know that cheaper gasoline boosts consumption. This is just a cycle and once the equity markets find a bottom the cycle will reverse with energy stocks and commodity stocks becoming favorites again.

I would be a buyer of energy stocks at this level. I would buy the drillers and service companies that are not specifically linked to the price of oil.

Jim Brown

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