What to Do About Oil, CAD and Yields

This week, we wrestled with what to focus our Market Ethos on, given the many big moves we have seen in the markets including yields, the Canadian dollar (C$) and oil. Our problem stemmed from the fact that these three topics were covered in the previous three weeks of Market Ethos (see links above). We don’t want to write a ‘re-run’, but given the number of client inquiries on these three topics received over the past week, a revisit seems prudent. So here’s what we’re doing about oil, CAD and yields.


Oil – Supply is the Issue

Oil prices have retreated back down to below $45/barrel. What makes this more troubling is this has occurred with record demand, which continues to grow at a decent pace thanks to broadening global economic growth. Clearly the issue is on the supply side, with some faltering within OPEC on production cuts and rising U.S. production.

In May, according to IEA, the world consumed 96.9 mbpd, and yet produced 98.1 mbpd. This is the highest surplus, 1.2 mbpd, since before the announced OPEC production cuts. China oil imports were 15% higher in May of this year compared to a year ago. U.S. consumption is 4.2% higher. So clearly it is not a demand issue, which is a good thing.

Supply remains the issue. OPEC, after a number of months of contracting supply thanks largely to seasonality and cuts, has started to raise it again (blue line, top graph). At the same time U.S. production continues to climb, nearing its pace from when oil was much higher (orange line, same graph). Not a good combination for the commodity price. The number of drilling rigs in the U.S. has been rising for a year and is at two-year highs. DUCs are also back (DUCs = Drilled but uncompleted wells), 5,000 in the four major shale zones is a record high.

Even more troubling than just the commodity price is the underlying stock prices. During recent periods of commodity strength the sector just hasn’t risen as much as the commodity. And since 2017 started, the energy sector is the worst-performing sector for both the S&P 500 and TSX.

Our Portfolios Remain Underweight Oil

We remain significantly underweight energy and more defensively focused, mainly on integrateds and some pipes. This stance has not changed. However, with oil now below $45/barrel and prices starting to look more attractive, we are nearing a phase at which we would consider adding. But not yet.

One aspect that is starting to make oil perhaps nearing oversold levels is the rapidly declining number of net non-commercial futures contracts. If these tick much lower when the data is released on Tuesday and the stocks continue to slide, we may switch our fundamental hat for a contrarian hat and do some buying.


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