The end of the year has arrived but the storm in the risky assets did not get any relief. The panics that started with the end of the QE asset buying took an end in the stock market with the statement of being patient with the rate hikes but the interest rates of the junk bond with under investment grade credit rating are soaring.
The panic regarding the Fed's interest rate hikes and the very serious decline in energy prices in the market where the US has a size in excess of 2 trillion USD and the size of the Emerging countries' stock estimated as being between 600 billion USD and 1.1 trillion USD, causes the threat of a serious bankruptcy and default. Even if there isn't any threat of default in some cases, it will become very expensive to issue new bonds in the coming months.
Following Yellen's warning in August regarding the over-valuation, the weather suddenly changed in the junk bonds that were the brightest asset class in 2014. The investors realized that the returns had dropped significantly and thus started to shun the new issues. At the end of November, the annual return on these assets had already become nil.
The drop in energy prices, a couple of minor default cases in the Chinese bond market and the rise in bond yields in the 2-year bonds in the US were also one of the straws that broke the backbone of the market. Currently, while the return in the energy companies' bonds have risen to double digits, the spreads in the others, that is the interest rate difference with the US government securities in peer-term, began to expand as the market indicated that the default risk was on the rise.
Widening of the spreads does not indicate the deterioration of the financial condition of the company; on the contrary, as the energy constitutes an input for all the companies, their costs are going to drop significantly. However, the liquidity is tight in the markets and the existing funds have started to move to the private sector bonds with high credit rating and to the US government securities.
Many companies had issued new securities under the assumption that the maturing bonds would be rolled-over. If they are forced to redeem them due to the rise of the interest rates, they may default. And the defaults could put into trouble the leveraged funds that hold them in their portfolio. This wave of defaults could well spread to the stock market.
The risks regarding the raising of the interest rates by the Fed by mid-2015 and the harsh decrease in the available foreign currency reserves in Russia's central bank could reach proportions that could ignite a panic in the financial markets. And the spark that could set the fire on may come from China. China is the number one issuer through Hong Kong in the Emerging Economies section of this asset group and is also the most risky country. In particular, the situation of companies operating in the housing sector is faltering. Currently, China's private bonds are standing tight based on the assumption that the Chinese government will not allow the bankruptcy of the debtor companies. In the event that Beijing changes its attitude, a real panic could start in the junk bond market and could spread to all risky assets...
Saturday 27 December 2014
Thursday 4 December 2014
BOOM BUST SEQUENCE IN OIL
During a market turmoil, any asset can drop severely and investors who are trying to catch the bottom of this free fall end up losing their money and sometimes their fortunes in the process. During such an environment, it is rather difficult to tell whether the drop in the price is heading for a crash or is only a correction, often a short-term one.
The recent drop in the oil prices reminds us about the dilemma faced by every investor or trader: is it a crash or a short-term correction? Oil prices dropped by more than 35% since early summer and more than 50% from its top of 147 USD a barrel which was reached in 2008. When you have such a severe drop, you start to ask to yourself whether it is time to buy it? A correction of 50% is enough for many investors and traders to start buying but what if it were to drop further to 60 USD a barrel? One should look for the possible catalysts that would permit a comeback of the oil...
A low price in oil stimulates the demand in many related sectors but diminishes the exploration and development thus reducing the oil supply with time. At one point, the demand starts to push the price of oil until a point is reached where the imbalance between supply and demand reverses the process and we have a severe drop if not a crash in the price of oil.
Currently, many oil producers (many of them being high-cost producers) have a break even price in the range of 60-70 USD and if the prices were to continue to drop, they will get into trouble: their budgets for capital expenditure will record a loss and a drop in the supply will follow; currently, there are deferrals and delays and their cost structure don't make that profitable at 70 USD a barrel. And the long-term outlook for the industry is moderate; in fact, the price of the barrel may remain flat around 70 USD for some time to come.
But there is also the production level of the conventional oil approaching the peak level. Despite the development of the unconventional oil production (oil sands, U.S. oil shale, biofuels and natural gas liquids), the drop in the price of oil will hurt their production as they are costly. Their production determines the growth in the production of oil in general and they depend too much on higher price levels. Further, the current levels of the oil prices will hamper the development of electric and /or hybrid cars as their operating costs are higher.
The oil producing countries in the Middle-East and Africa, as well as Russia need prices that are higher than 70 USD a barrel in order the break-even with their budgets (Russia has a break-even level of 85 USD a barrel) . Saudi Arabia has a strong financial position which will permit her to withstand for long years of low prices (thus allowing her to drive out competitors such as U.S. oil shale producers) but the other oil producing states do not have that luxury; if the low prices persist for some time, they will reach a limit and production cut will follow thus driving up the price of oil.
The energy stocks got hurt from this process and we can find many beaten stocks in the industry. This also leads us to believe that one should feel bullish as far as the pessimism is concerned. The depressed energy sector forces us to think that there are some value stocks present there but currently the investors look to the short-term. With no replacement of the fossil fuel in the near future, the long term outlook of the sector is still bright. The most important factor which affects the oil price is the growth in the world's economy and the current slow growth is affecting adversely the price of the oil. But a surge in the demand for oil from countries such as China and India will create a shortage in the supply of oil and the price will go up. And the current selloff witnessed in the energy sector is currently telling us that the worst being left behind; soon, a rebound will start but it will be a slow one. Nevertheless, the price of oil should fluctuate in an upward trend, reaching the target price of 180 USD a barrel in the long run.
The recent drop in the oil prices reminds us about the dilemma faced by every investor or trader: is it a crash or a short-term correction? Oil prices dropped by more than 35% since early summer and more than 50% from its top of 147 USD a barrel which was reached in 2008. When you have such a severe drop, you start to ask to yourself whether it is time to buy it? A correction of 50% is enough for many investors and traders to start buying but what if it were to drop further to 60 USD a barrel? One should look for the possible catalysts that would permit a comeback of the oil...
A low price in oil stimulates the demand in many related sectors but diminishes the exploration and development thus reducing the oil supply with time. At one point, the demand starts to push the price of oil until a point is reached where the imbalance between supply and demand reverses the process and we have a severe drop if not a crash in the price of oil.
Currently, many oil producers (many of them being high-cost producers) have a break even price in the range of 60-70 USD and if the prices were to continue to drop, they will get into trouble: their budgets for capital expenditure will record a loss and a drop in the supply will follow; currently, there are deferrals and delays and their cost structure don't make that profitable at 70 USD a barrel. And the long-term outlook for the industry is moderate; in fact, the price of the barrel may remain flat around 70 USD for some time to come.
But there is also the production level of the conventional oil approaching the peak level. Despite the development of the unconventional oil production (oil sands, U.S. oil shale, biofuels and natural gas liquids), the drop in the price of oil will hurt their production as they are costly. Their production determines the growth in the production of oil in general and they depend too much on higher price levels. Further, the current levels of the oil prices will hamper the development of electric and /or hybrid cars as their operating costs are higher.
The oil producing countries in the Middle-East and Africa, as well as Russia need prices that are higher than 70 USD a barrel in order the break-even with their budgets (Russia has a break-even level of 85 USD a barrel) . Saudi Arabia has a strong financial position which will permit her to withstand for long years of low prices (thus allowing her to drive out competitors such as U.S. oil shale producers) but the other oil producing states do not have that luxury; if the low prices persist for some time, they will reach a limit and production cut will follow thus driving up the price of oil.
The energy stocks got hurt from this process and we can find many beaten stocks in the industry. This also leads us to believe that one should feel bullish as far as the pessimism is concerned. The depressed energy sector forces us to think that there are some value stocks present there but currently the investors look to the short-term. With no replacement of the fossil fuel in the near future, the long term outlook of the sector is still bright. The most important factor which affects the oil price is the growth in the world's economy and the current slow growth is affecting adversely the price of the oil. But a surge in the demand for oil from countries such as China and India will create a shortage in the supply of oil and the price will go up. And the current selloff witnessed in the energy sector is currently telling us that the worst being left behind; soon, a rebound will start but it will be a slow one. Nevertheless, the price of oil should fluctuate in an upward trend, reaching the target price of 180 USD a barrel in the long run.
Subscribe to:
Posts (Atom)