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Now That's A Rally!

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The markets celebrated the global effort to rescue the financial system with a +936 point Dow gain. That is the kind of short squeeze that puts real fear into the bears. Crude was up +4 as hopes for dodging a global financial recession suggested demand would not drop as sharply as expected.

However, as I have been saying for a couple weeks it was not fundamentals driving prices down buy forced liquidations by investors hit with margin calls and fund redemptions. Any positive market of this magnitude will float all boats for at least the very short term. That was why crude rose today. It was a rally by association rather than specific buying interest.

Tuesday will be an interesting day. There will be more details about the Treasury bailout and equity infusion. That could be good or bad but it would be hard for anyone not to believe that the news was not already priced into the market. The bond market was closed on Monday and they could be a driver on Tuesday as they catch up with the news.

I would love to think that there were enough dazed shorts left in the markets to continue this monster short squeeze tomorrow but I suspect most of their stops were hit today. The magnitude of the gains would have bankrupted anyone short and not protected. That suggests tomorrow could see some buyers remorse after any opening bounce.

A result of the drop in oil prices is sharply dropping gasoline prices. The national average on Sunday was $3.25 per gallon but 13 states had individual averages under $3. That should convince Joe sixpack to rush out and buy a new truck or SUV. Once the pain of high prices has passed the memory quickly fades. Americans still believe the peak oil story is a hoax and there will always be cheap gasoline because there are still billions of barrels of oil to be found. The majority of people never give it a passing thought until the next price spike steals their paycheck.

Iraq put up 100 billion barrels of oil for bid by international companies but despite the oil being relative easy to extract it could be years before there is any progress. The dispute over who will reap the proceeds is likely to keep it tied up in politician hell for months to come. Everybody wants to claim a portion of the fields with the Kurds already signing their own agreements to have the oil produced. The value of 100 billion barrels guarantees political fighting for quite some time.

CIBC's Jeff Rubin said the marginal cost of a new barrel of oil today is between $90 and $100. Others have said the cost for an offshore barrel is $85. This suggests there will be voluntary unannounced cutbacks if prices continue to fall. Nobody wants to produce oil for a loss.

A Merrill Lynch analyst said the inflationary impact of all the financial bailouts could push oil prices back to $150 long term.

Venezuela is spending about $9.2 billion per year subsidizing gasoline for its citizens. Gasoline in Venezuela costs the buyer about 14 cents a gallon. If Hugo Chavez wants to remain in power he can't raise the price. Rumors of a price increase always causes civil unrest. 

Pemex is still struggling to restart production on 250,000 bpd that was knocked offline nearly two weeks ago. Pemex has also lost days of production due to bad weather in the gulf. Sometimes nothing goes right for you.

U.S. crude production is expected to fall below 5 mbpd for the first time since World War II. The problem is twofold. One is the constant decline due to depletion and the other is the loss of production from the gulf as a result of the hurricanes.

Jim Brown

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