It looks like global markets want to put Brexit behind them. Yet despite a significant rebound, bond yields and the gold market suggests we have not had the last panic on Brexit just yet. On one hand the rise in gold and the drop in global security yields seem to suggest that there is more fear ahead or at least more global economic stimulus. We could also be seeing some buying in gold and bonds in response to the awful terrorist attack at the Istanbul airport in Turkey.
For oil the fallout from Brexit has taken its toll. The market is selling off on fear of what might be as opposed to what is. Fear that we will see a global recession is overtaking the rapidly improving market fundamentals. Not only are we seeing record demand for gasoline and great demand for oil, but also signs of falling production and supply. The latest evidence we have of that trend comes from the American Petroleum Institute, which reported a 3.9-million-barrel drop in U.S. crude supply. The report also showed a 1.2 million-barrel drop in the Cushing, Oklahoma delivery point which was pretty much in line with what the private forecasters had predicted.
For products, the 800,000-barrel drop in distillate and the 400,000-barrel drop in gasoline at the very least shows that refiners are staying pumped up for what is predicted to be record-breaking demand over the Fourth of July holiday weekend.
Supply worries abound. Not only do we have the threat of a Norway oil and gas worker strike this weekend, we have reports that we may see another plunge in Venezuela’s oil output. Bloomberg News reports that Venezuela’s oil output, already the lowest since 2009, is set to slide further this year as contractors scale back drilling after the country fell more than $1 billion behind in payments. Barclays (LON:BARC) estimates that Venezuela’s oil output will fall to 2.1 million barrels by the end of the year.
Bloomberg also is warning that North Sea oil production will also struggle. Concerns about the fallout from the Brexit vote on UK oil companies is causing the UK government to forgo collecting tax so they can continue to invest in high cost projects in the North Sea to fight declining production. Bloomberg reports that, “The industry would face an even longer period of turmoil if the U.K.’s EU exit were followed by a split with Scotland. A spokeswoman for BP (LON:BP) said the question of the future of Scotland in the U.K. isn’t a question for the company but it will “monitor the situation closely.” Royal Dutch Shell (LON:RDSa), Europe’s largest energy company, reiterated its position during the 2014 referendum, saying it would prefer to see Scotland remain part of the U.K.
Bloomberg warns that here may be a pause in investment while companies assess uncertainties, including the possibility of another Scottish referendum, said Ian Thom, senior research manager at Wood Mackenzie Ltd. The Edinburgh-based consultant estimates that North Sea investment will decline by 79 percent from 2015 to 2020.
Which of course plays into my scenario that in the long term we are going to see a supply squeeze as we see more retrenchment in oil investment. In the short term,, oil has to be on guard for a possible demand drop due to a slowdown in the European economy. Yet today the market is giving the demand side the benefit of the doubt because really nothing has changed yet except perception. Still, to think we have seen the last of the fear due to the Brexit is wishful thinking. We still believe this is a historic time to think long term for what is proving to be a generational bottom for this market. Use weakness to establish long term bullish positions. While in the short term trade I would like to see sharp break before I am convinced that the worst is over.
We also have been talking about a natural gas bottom and that market exploded on the July expiration. The rally was helped by weather forecasts that may see record braking temperatures in the month of July. This comes as U.S. natural gas production is peaking and is expected to fall further in the coming weeks and a natural gas plant in Mississippi that had two explosions that will further crimp supply. Production is the shale areas one percent below a year ago and demand is 10% higher than last year. We have said before that natural gas is a bullish accident waiting to happen and that accident, along with weather, was good for a 7% rally.
Worries overall are giving gold a boost. Even with the risk off scenarios. Warnings about explosive inflation down the road by Alan Rescan and more risk of terror, not to mention currency risk, is giving gold more reasons to shine. Even with the strength in the dollar, gold did well and is rebounding today along with stocks.