If you read the reasons for all of the wild moves in the commodities markets yesterday, you will read a lot about Ben Bernanke and perhaps reducing the chances for quantitative easing and economic data. You will read of upbeat Federal Reserve Board minutes and end of the month profit-taking. Yet, what you won't read a lot about but perhaps had as big of an impact as anything on trading was what can be described as the North Korean effect.
In a market where the geopolitical risk premium has been pumped up to a frenzied high mainly because of Iran, any sense that we might see a reduction in that risk premium would move markets in a big way. Market prices act exactly as you might expect if that risk had been reduced. Precious metals plunged and oil rallied back taking a hit after a bearish inventory report and the size of the moves were accentuated on the shocking and hopefully historic news coming from the State Department surrounding the North Korea Nuclear Program.
The New York Times broke the story by reporting that North Korea announced on Wednesday that it would suspend nuclear weapons tests and uranium enrichment and allow international inspectors to monitor activities at its main nuclear complex, a step that raised the possibility of ending a diplomatic impasse that has allowed the country's nuclear program to continue with no international oversight for years. It also said North Korea agreed to suspend its uranium-enrichment program, nuclear weapons tests and long-range missile launches in return for 240,000 metric tons of food aid from the United States.
While some experts think that this so-called moratorium on uranium enrichment does not really mean anything the news might suggest it leads to, a historic breakthrough could change the fate of many commodities going forward. If you think about it, the markets acted just like you would expect if North Korea were indeed to begin stepping back from its nuclear program. Though we learned from the new leader's father and grandfather that North Korea can’t be trusted, even a slight reduction in that tension can impact prices when that geopolitical risk premium is already high.
The big drop in gold was the most obvious reduction in the geopolitical risk premium. Many people have bought gold as they fear the aftermath of geothermal nuclear war. OK, I exaggerate a bit, but it has been obvious that gold historically rallies during times of war and uncertainty. Gold has performed as the risk-on play. Many times it has involved the rising fears surrounding Iran and that has been obvious in recent weeks. Oil, of course, just last week had the biggest influx of speculative open interest since May, based mainly on an increase in the Iranian Risk premium. If North Korea starts playing nice with the West, that will further isolate Iran as the “Axis of Evil" club may lose another member. According to The New York Times, Secretary of State Hillary Clinton said in congressional testimony that the “’announcement represents a modest first step in the right direction. We, of course, will be watching closely and judging North Korea's new leaders by their actions.’” And so will the markets.
White House spokesman Jay Carney was quoted as saying that North Korea's latest commitments “are very welcome, but obviously they need to be followed up by action." He said the United States is not formally linking its food assistance to any North Korean moves toward denuclearization.
Now, while it is likely that we are being played for a fool again so the North Korean regime can score some food for its chosen ones, it is also possible that this could be a new opportunity. The West, wanting to encourage this new behavior, will shower North Korea with cash and goodies, and that in turn will increase the demand for oil, grains, cocoa and sugar. In fact, already it is food that is turning North Korea. I know that in the past North Korea has taken our food and money only to covertly continue along that same evil path. Yet, with King Jong Il out of the way, perhaps maybe, just maybe, King Jong Un might not be as crazy as the old man. This could even knock a few minutes off of the world’s doomsday clock. Now I may be getting ahead of myself but, again, that’s what futures markets do.
Today, that risk premium may be creeping back as Bloomberg News is reporting that:
"Obama administration officials are escalating warnings that the United States could join Israel in attacking Iran if the Islamic republic doesn’t dispel concerns that its nuclear-research program is aimed at producing weapons. Four days before Israeli Prime Minister Benjamin Netanyahuis scheduled to arrive in Washington, Air Force Chief of Staff General Norton Schwartz told reporters the Joint Chiefs of Staff have prepared military options to strike Iranian nuclear sites in the event of a conflict. ‘What we can do, you wouldn’t want to be in the area,’ Schwartz told reporters in Washington yesterday. Pentagon officials said military options being prepared start with providing aerial refueling for Israeli planes and include attacking the pillars of the clerical regime, including the Islamic Revolutionary Guard Corps and its elite Qods Force, regular Iranian military bases and the Ministry of Intelligence and Security. The officials spoke on condition of anonymity because Pentagon plans are classified. ‘There’s no group in America more determined to prevent Iran from achieving a nuclear weapon than the Joint Chiefs of Staff,’ Joint Chiefs Chairman Army General Martin Dempsey told the House Budget Committee yesterday. ‘I can assure you of that.’ Separately, unnamed U.S. officials told the Washington Post that U.S. military planners are increasingly confident that sustained attacks with the Air Force’s 30,000-pound (13,608 kilograms) ‘bunker-buster’ bombs could put Iran’s deeply buried uranium-enrichment plant at Fordo out of commission.”
Of course, you do have the QE impact, as well. Still, I find it hard to believe it could cause that massive move when economic data and the Fed fund futures have already been suggesting that a new round of QE is less likely. In China the PMI came out higher than expected and one might expect less of a chance of a Chinese shot of stimuli. Yet, we do not see the major moves we saw yesterday.
Regarding my article yesterday, it seems that as far as a new investigation on gasoline prices, I was mistaken and the FTC pointed that out to me. The story that sparked my article was retracted by Reuters who wrote the alert and story headlined "U.S. FTC opens investigation on oil prices" is withdrawn because the Federal Trade Commission mistakenly issued an old press statement on Tuesday concerning an ongoing investigation, not the opening of a new one. So I apologize to the FTC for the mistake.
But I do not apologize for the sentiment in my article. The American people are tired of trying to find scapegoats to explain rising gasoline prices when the reasons are clear and make sense if they are told them truth. While it might be politically convenient, the truth is that these witch hunts could actually do dame and harm the American public. The latest is this war against "speculation" and the misinformation that is being fed to the American Public who seemed to get wise to the fact that it isn't the evil oil companies that are keeping prices high.
Yesterday, Roberta Brampton of Reuters reported, “As U.S. gasoline prices surge and Capitol Hill rhetoric heats up about who's to blame, a familiar villain has been revived: the speculator. A group of Democratic lawmakers in the House of Representatives urged Gary Gensler, the top cop for U.S. futures markets, to crack down on speculators who they argue are artificially inflating oil prices. ‘Right now, oil speculators are cynically exploiting fears relating to U.S. and European efforts to prevent Iran from getting nuclear weapons,’ said Edward Markey, a Massachusetts Democrat, at a news conference on Wednesday."
It is obvious that congressman Markey does not understand how wrong and insulting that slanderous statement is. Oil speculators do not cynically exploit fears; they assume the risk of others that are panicking, allowing order and the continuity of supply. What Mr. Markey fails to acknowledge is that these fears are already impacting supply and demand. We have seen a surge in buying in Asia and Europe as they seek to hoard supply before a disruption. Business and producers saved billions of dollars by speculators assuming this fear risk and if they did not exist and we failed to get reliable price discovery then supply might dry up.
Reuters also said that "Secretary of State Hillary Clinton suggested to lawmakers on Wednesday that the recent gasoline price jump was not justified by geopolitical tensions in Iran, Syria and Libya. ‘I am skeptical about the reasons for the increase in gas prices. I think that deserves careful attention by the Congress. Because there is supply,’ Clinton told the House appropriations subcommittee in charge of foreign aid, ‘I think the increase in prices is hard to explain based on the facts as we are aware of them.’” Of course, while I have a higher degree of respect for Secretary Clinton's knowledge of the futures markets, the truth is she has more experience in the cattle market than she does in oil. Reuters goes on to say that, "Over the years, academics and analysts have sparred over whether the $300 billion in institutional investment poured into commodity markets during the past decade has been responsible for price spikes. But in the wake of the last gasoline price run-up in 2008, when oil prices hit historic highs, lawmakers pressed the Commodity Futures Trading Commission to clamp down, an effort that became part of the Dodd-Frank financial regulations. The CFTC had planned to begin enforcing its position limits in June, but lobby groups for the financial industry have challenged the agency in court, arguing it went too far, and are seeking an injunction to block it.”
In fact may people believe that if this legislation is passed, it could cost business's billions of dollars that will be passed on to the consumer.
Well, anyone that reads the energy report knows why oil prices went up in 2008. It was not speculation, but it was the markets reacting to the greatest economic crisis since the great depression.
Phil Flynn is senior energy analyst for PFGBest Research and a Fox Business Network contributor. He can be reached at (800) 935-6487 or at pflynn@pfgbest.com.
