Momentum is GREEN. This afternoon, the S&P 500 rallied to new, near-term highs before a brutal round of profit taking took the markets in reverse. Buying momentum is strong, and selling is still quite low. There is a path to 4,300 for the S&P 500, but you MUST be very cautious right now.
Another day… another rally. Before we talk crude oil, I want to discuss PPI. This morning, the Producer Price Index registered under expectations, and the month-over-month “inflation” metric fell about 0.5%. Over at every economically ignorant media outlet possible, headlines read that “Wholesale prices” fell for the first time in two years.
Well, bad news media. The PPI isn’t wholesale… and it hasn’t been that way since 1978. What does PPI actually do? It measures changes in how much the producers of raw goods, services, and construction get paid. That’s it.
These are typically the first purchases at the very beginning of the supply chain – regardless of their end-use. It’s a measurement of these producers’ incomes. You hear a lot of people say that the PPI dictates wholesale prices that end up being factored into what U.S. consumers pay. Wrong again.
PPI also measures what foreign companies and governments pay for these products and services. You can’t suggest that things bought by the government of France in Louisiana will impact the price of something in Washington state. Meanwhile, it’s very hard to actually calculate what the price at the front of the supply chain will lead to a price in a specific product.
Think of it this way. Corn prices might fall, but good luck accurately predicting the price of medicines using corn-based chemical “dextrose” or rain jackets in six months that use oil-based chemicals called per- and polyfluoroalkyl in the future from these readings. So, in an effort to dumb down the PPI, the media screwed up the basic definition.
Conclude Rant, Garrett
Okay, I’ve gotten that out of the way. But the more important thing to consider is that the PPI tends to move up or down – largely thanks to crude oil prices. And everyone is celebrating the eight-week decline in gasoline prices too.
Only in America can we have a stock market rally thanks to inflation ONLY being 8.5%. Only in America can we cheer that homes were less “less affordable” in July. But here we are. This is why one should drink. But I dug through these CPI and PPI numbers… and people need to be very careful right now. The core PPI numbers less food fell more than 4% today.
Why does this matter? Because it’s a sign that consumers are tapped out. They are turning to staples. I stress this very important little metric: Housing and durable goods are critical to economic growth. So this belief that we’re about to see GDP hit 2.5% in Q3 – according to the Atlanta Fed – is quite a tale. The reason why CPI and PPI are down is because of falling oil prices.
Now, everything has a supply and demand balance. Oil prices are partially falling because the White House is selling 1 million barrels per day from the Strategic Petroleum Reserve. But that’s less oil than Americans use in 90 minutes.
Why Crude Oil Fluctuates
The primary reason why oil prices have fallen is because U.S. consumers have stopped buying the stuff at normal levels. (There are two other, major factors, but I’ll get to those in a moment). It’s outright insane that people are consuming less gasoline in what some mainstream economists are calling “a healthy economy.” Consider this: U.S. gasoline demand TODAY is lower than it was during the height of the COVID outbreak in the summer of 2020.
This is NOT a healthy economy.
Despite all of the concerns about a recession… and the possibility of even more economic pain, WTI crude is still hovering near $94 per barrel. That tells you a lot. Because the other two major demand issues are starting to emerge. First, China has locked down millions over new COVID restrictions. The second that China starts to ease on its monetary policy AND lifts the lockdowns, that demand will put more pressure on prices.
Second, the International Energy Agency (IEA) just hiked its demand forecast by more than 380,000 barrels per day. Why? Because natural gas prices are so high that nations will have to burn OIL to keep the lights on in the next few months. Then, consider the very obvious. U.S. storage recently hit lows not seen since 2008.
More so, the White House SHOULD stop selling 1 million barrels per day in October when the plans expire. It’s possible that the White House bleeds the entire Strategic Petroleum Reserve dry to try to contain prices (this thing eventually has to be refilled too… so that’s a demand issue). Once that deal ends, we will see far less pressure on the front-month contract.
Finally, consider the fact that U.S. demand for gasoline is so low. If this economy were in anyway to magically recover, Americans would have more money in their pockets… and demand would start to rise. Do the math.
Supply < Demand
I honestly don’t think that people have quite figured out that even in a recession, oil prices will likely remain elevated for the foreseeable future. Yes, we might get back to the $85 level, but there’s no real pathway to increasing supply in a robust manner, and capital constraints and higher taxes on production will only “fuel” higher prices.
Yes, downside does exist, but policy offers the floor here, and we are witnessing a robust opportunity for long-term appreciation in the oil patch.
As always, I love Crescent Energy (CRGY) – which just crushed earnings. And I have consistently stood by Devon Energy (DVN), Occidental (OXY), and ConocoPhillips (COP). I’ll talk about the downside risks tomorrow… And how to trade these stocks if you think crude oil is moving to $85 in the short term.