Crude oil sell off goes through the $81 handle

Market Review

Friday and Monday's sessions saw the S&P drive strongly lower in the final hour of the US trade to extend the three week downtrend. Yesterday the index threatened to repeat the same pattern with a strong sell off to test Monday's low but crucially the support level held and the index bounced to post a small up day thus avoiding what would have been the first four consecutive down day streak of 2014. Our Nasdaq strategy followed this range bound scenario perfectly and booked whoever traded it some 188 ticks to the first target. Crude oil continued its way lower, however we will discuss this in more detail below. The FX sector had some decent movement in the morning hours which saw a move lower in both cable and EURUSD, however this was not a dollar move as both the Euro-zone as well as the UK posted poor economic data which lead to the sell off. The ZEW later mentioned the potential of QE and that the Bundesbank should be open to such measures after new data suggests Germany may technically enter in to a recession.

Today's Fundamental View

The largest mover this morning has been crude oil with a sell off through yesterday’s low and the $81 handle. Considering unofficial conversations with the Saudi’s that have been leaked stating they are comfortable with a price even down to the $70 handle it suggests further downside is likely despit a 25% sell off already. There are many theories as to why crude is trading this low, with the most dominant being that a price below $100 and lower is the breaking point for many producers which compete with Saudi Arabia for market share and this will effectively halt projects in deep water and shale oil. The oil rich country is famous for its low break even point, and can for a time effectively delay projects around the world, but it is important to note that this comes at a cost! By lowering the production by say 20% which is rather high at this point, one can assume an increase in the price to a very conservative $100 per barrel if the slack is somewhat made up elsewhere in the world. The Kingdom will get $800 million income per day in this scenario; which coincidentally is the same as it gets by 10 million barrels at $80. What this effectively means is that it is giving away 20% of its natural resources for free as eventually any field that can be developed, will be developed. We also question the reasons for the lowered price tag, as it comes at a very inconvenient time for Russian President Putin and his endeavours in Ukraine. Russia, with its budget balance price at $117 (Brent) for 2013 will under current sanctions and squeeze on its most important natural resource see itself being forced to withdraw or face the potential of an economic ruin and a lost decade. As this hits Russia harder than any other nation (US consumers are happy about a lower price) we believe there is a firm connection, also in terms of the timeline of this sell off in crude. This afternoon is set to be an interesting session with retail sales and business inventories which shall measure the temperature on the American consumer. With the recent jobs numbers we remain positive on this data, as we do on the inflation number for producers and manufacturing numbers. The earnings calendar shows Bank of America to continue the financial sector earnings and we believe the sector will continue to perform, as we saw with Citi and Wells Fargo yesterday. This may lead to the S&P and US10Y, as suggested yesterday, decouple a bit from its European counterparts. As much as we believe in the stock market and see a reversal shortly if the earnings season continues positively, it is difficult to fight the trend and we will for this reason remain short on equities and long on bonds, with a short on the EURUSD to illustrate the poor performance in European data. Crude oil is a straight forward sell, although we remain alert for short term retracements to the upside.

Alternative View

No news may lead to low volume and adverse market conditions. Monetary policy will be dictated by arbitrary speakers which can alter direction of the market.