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Declines Being Led by Commodities and Biotech

It is getting ugly.  The Bloomberg World Mining Index fell to the lowest level in almost seven years.  Other gauges fell to levels last experienced in 2013.

As inferred the declines were led by the commodities and biotechs, with the NASDAQ biotech index falling another 6%.  This former high flying sector is now down 27% from its all-time momentum fueled high reached 2 months ago.

Many times I have opined when selling commences in an over owned sector, who is left to buy?

I am long oil, a sector that has been completely decimated.  Some are making analogies that the biotech sector will follow the oil sector.

While I do not know if this will occur, I will argue the reason for oil’s decline is entirely different than the biotech decline. Unlike the biotech implosion, the decline in oil is threatening the very existence of countries.  This precipitous decline in oil is brought upon by Saudi policy and such a policy can be changed or some other externality can occur causing prices to rise.

The Financial Times wrote an interesting article about Saudi Arabia, especially relating to internal strife.  According to the FT, Saudi Arabia is facing the great inner turmoil since 1964, the last time there was a regime change.  The cause of this unrest…plunging oil and the war in Yemen that is causing severe economic distress.

The FT states Saudi Arabia’s 2015 budget is based upon $90 barrel but according to some “insiders,” the budget requires $108 oil because of the war in Yemen and additional transfer payments to quell their young and unemployed youth.

2016 budget is almost as ugly, requiring $90 oil.  But it was the next paragraph that really got my attention.  The FT states that Saudi Arabia can last another 12 months with prices at current levels because of capital flight before facing a potential severe economic crisis that is now prevalent in 7 out of 12 OPEC members.

I rhetorically ask will Saudi Arabia cut production to ease financial pressures?  Will there be regime change that will produce civil unrest and/or a cut/disruption in production?  What are the ramifications of seven OPEC’s members already teetering on the edge of the financial abyss because of Saudi policy?

It is widely accepted the Middle East is undergoing the greatest change since the 1914 dissolution of the Ottoman Empire.  I am a firm believer in the phrase “most often the most obvious conclusions are ignored.”

During the past 12 months oil has plunged at the same rate as the Middle East has plunged into chaos.  Historically oil prices rise in the face of Middle East violence.  Will all wake up one day and oil will be 25% higher because of some externality?

While the merits of the FT story can be debated, I think it offers considerable potential insight into the world’s most important oil producer and exporter.

Returning back to the biotech implosion, I think other than a sharp and painful drop, there is little comparison to that of the oil sector.

What will happen today?  All markets are chaotic because of the uncertainty in the macro economic and monetary backdrop.  Will this chaos increase if the anarchy in the Middle East becomes a market variable?   Unfortunately yes.

Data released yesterday indicated that domestic household spending climbed more than expected in August indicating that the US consumer is weathering the perceived global slowdown.  What will the upcoming employment statistics suggest?

Last night the foreign markets were down.  London was down 0.53%, Paris down 0.02% and Frankfurt up 0.16%.  Japan was down 4.05% and Hang Sang down 2.97%.

The Dow should open moderately higher after Monday’s rout that wiped out $800 billion in global values.  Gains are being led by oil and other commodities.  The 10-year is off 3/32 to yield 2.11%.

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Ken Engelke

Chief Economic Strategist Managing Director

The views expressed herein are those of Kent Engelke and do not necessarily reflect those of Capitol Securities Management. Any opinions expressed are statements of judgment on this date and are subject to certain risks and uncertainties which could cause actual results to differ materially from those currently anticipated or projected. Any future dividends, interest, yields and event dates listed may be subject to change. An investor cannot invest in an index, and its returns are not indicative of the performance of any specific investment. Past performance is not indicative of future results. This material is being provided for informational purposes only. Any information should not be deemed a recommendation to buy, hold or sell any security. Certain information has been obtained from third-party sources we consider reliable, but we do not guarantee that such information is accurate or complete. This report is not a complete description of the securities, markets, or developments referred to in this material and does not include all available data necessary for making an investment decision. Prior to making an investment decision, please consult with your financial advisor about your individual situation. Investing involves risk and you may incur a profit or loss regardless of strategy selected. There is no guarantee that the statements, opinions or forecasts provided herein will prove to be correct. If you would like to unsubscribe from this e-mail distribution, please reply to this e-mail and indicate that you wish to unsubscribe in your response.