Rahm Emanuel Paging Oliver North

Will Civil Unrest In Iran Push Oil Over $100?

Probably not.

While reports of clashes with security forces in Tehran persist, the protests of "thousands," confined to the Interior Ministry in the capital likely won't amount to anything substantial before markets open again. Security forces have an effective grip on Iran and one expects that widespread unrest would be dealt with harshly. Even a few thousand protestors are unlikely either to persist long or prevail absent another catalyst or galvanizing event. Like clockwork, security forces arrested 10 leaders of reformist groups who supported Mousavi. Preventative detention at its finest. Cell phone coverage was cut off in the capital as well as internet access to moderate websites. Many foreign journalists were called and told their visas would be revoked and that they should prepare to leave the country. A motivating event isn't impossible, but probably is very unlikely with this kind of crackdown. It's easy to roll around with riot police, until they start shooting.

International concern over the election results and accusations of "fraud" are unlikely to amount to much. If the potential development of nuclear weapons hasn't spurred more action from the international community, what exactly is a Chicago-style election result going to trigger? It's not like a long-standing and great Iranian democracy was somehow suddenly usurped, after all.

Despite all this, the Secretariat of Reza Pahlavi, the Crown Prince in exile, an unlikely ally for student protesters, issued this statement:

WASHINGTON, June 13 /PRNewswire-USNewswire/ -- Today the world is witnessing the demonstrated anger of millions of Iranians against a regime that denies their most basic rights, including the right to choose leaders who could improve their abysmal condition.

There is no exit from this condition, so long as one man appropriates onto himself the "power of god" and controls the judiciary, the media, the security forces and, through direct and indirect appointees, dictates the only candidates claiming to represent an impoverished and disenfranchised people.

Today I stand united with my fellow Iranians and call for the end of the Islamic Republic, or any other prefix in front of the name of my beloved Iran that indicates theocracy or any other form of disregard for democratic and human rights.

I caution the world that offering any incentives or "carrots" to the theocracy under these circumstances is an affront to the people of Iran. This is not a time for short-sighted, self-defeating tactical games. This is the time for the free world to stand true to its principles and support the people of Iran's quest for democracy and human rights.

SOURCE Secretariat of Reza Pahlavi

Weak protest or not, the Obama Administration probably wouldn't mind a little bit of good 'ole Middle East conflict right about now. Expensive oil is just the thing to boost the currencies of emerging market extraction economies (who hold a lot of dollar denominated debt) and pump up the market for U.S. Treasuries before China manages to cobble together a reserve currency of any worth (Russia went from holding ~$42 billion in U.S. Treasuries in March of 2008 to over $138 billion in March of 2009). A little cost-push inflation wouldn't be a terrible thing for an economy expecting to borrow $0.50 cents for every dollar it spends this year. No doubt the National Clandestine Service's Iran group is ordering early-morning pizzas tonight- that is if the powers that be learned the lesson from the Bush Administration about how economically stimulating a bit of regional conflict can be. Maybe we can actually settle the stories about those intaglio printing presses the Shah was supposed to have left behind in his rush to get some last minute shopping in Egypt done. Printing USD "Supernotes" is so 20th century though. If we drop a few pallet-bound Supertreasury presses from Geithner, James Geithner's garage we can kill several birds with one tactical drop:

- Overdrive printing of U.S. Treasury securities.
- Elimination of all leads in the Japanese Bondage/Kennedy Space Shuttle Billion Dollar Treasury fiasco.
- Fund the anti-Ahmadinejad insurrection with fake paper-slices of taxpayer dollars... which, in retrospect, are even better than the real thing.

Let's see:

Afghanistan: Civil War.
Pakistan: Civil War.
Iraq: Simmering Civil War.
Iranian insurrection: Hmmmmm. Green shoots! Sphere: Related Content

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The post-recovery US economy will still be weak and will get clobbered by commodities prices

By now, most smart money has typically pegged the US recovery in late 09, early 2010. ZH is somewhat dismayed to see the assumption being that once the economy gets going again, we're going to return to the '05-'07 levels of good times. However, we have to believe that we are merely going from disastrous to just kind of bad. Specifically, the next few years are not going to be pretty even once the deleveraging of the US economy is over. As we come out of it we're going to see a repeat of the infamous summer of '08 with oil hitting triple digits, except the header is likely going to be reflected across commodities not just oil. So, let's explore this idea...

THE US IS NOT RECOVERING INTO A POSITION OF STRENGTH

From a really macro view, 2000/2001 should have been the start of the corresponding secular bear market following the the post-'82 period but thanks to Greenspan's easy money, we managed to postpone the pain. The deleveraging that has occurred over this crisis can be viewed as correcting the past few years of easy money, but the underlying bear market still remains. The basis of the secular bear market is not particularly scientific, but given the 18 year movements from secular bull to bear to bull, etc. many were looking for the Internet bubble burst to merely be the start of the next secular bear market.  

On a more specific level, it is very interesting to note Bernanke's views (and David Rosenberg's take on those views) on the recovery and the positioning of the US economy. 

On the consumer side:

“… A number of factors are likely to continue to weigh on consumer spending, among them the weak labor market and the declines in equity and housing wealth that households have experienced over the past two years. In addition, credit conditions for consumers remain tight."

On unemployment:

“Even after a recovery gets under way, the rate of growth of real economic activity is likely to remain below its longer-run potential for a while, implying that the current slack in resource utilization will increase further. We expect that the recovery will only gradually gain momentum and that economic slack will diminish slowly. In particular, businesses are likely to be cautious about hiring, implying that the unemployment rate could remain high for a time, even after economic growth resumes."

On commercial real estate:

“Conditions in the commercial real estate sector are poor. Vacancy rates for existing office, industrial, and retail properties have been rising, prices of these properties have been falling, and, consequently, the number of new projects in the pipeline has been shrinking. Credit conditions in the commercial real estate sector are still severely strained, with no commercial mortgage-backed securities (CMBS) having been issued in almost a year.”

Finally, Rosenberg's summary of Bernanke's sentiment:

Bernanke knows any recovery will be fragile, at best

The whole recovery story boils down to government stimulus, the arithmetic from lesser inventory withdrawal, a reduced drag from housing and hopes that overseas demand will underpin exports. While Bernanke did try and sound optimistic, something tells us that he knows that any recovery, when it occurs, is going to be fragile at best, unsustainable at worst. Invest accordingly.

We couldn't have said it better ourselves. The bottom line is, there are a number of factors coming into play that we simply do not see accounted for in the current recovery story. We have to agree with Rosenberg's assessment, particularly when you weigh the general sunny bullishness that Big Ben has exhibited (in comparison with the usual tempered language of central bankers). 

COMMODITIES PRICES ARE GOING TO EXPLODE IN THE NEXT YEAR OR TWO

To be charitable, this is far from a controversial statement. However, despite the obviousness of it, we have to reiterate the point. There are two major factors that are going to make this time worse (or atleast different) in terms of commodity price shocks.

1) The US economy will not be leading the global economy out of the contagion

Pretty obvious, as we discussed above.

2) The US is consuming a lower market share of commodities, leading it to increasingly becoming a price-taker

Using the research we did into copper as an example, it's easy to see the shift and put some numbers on the anecdotal "China gets larger" picture. In just 3 years, the ratio of copper consumption in OECD:China:ROW went from 2:1:1 to 1.2:1.1:1.0. The specifics will vary from commodity to commodity but the larger trend remains. 

Commodity prices are highly responsive to the change of rate of GDP (as opposed to the actual level of GDP) and once we see the recovery kick in, prices will respond. Below, we see the correlation between commodities and rate of change of world GDP.

Thankfully, so far we have seen some respite following the dramatic crash of commodities last year (see below). However, a cursory glance is enough to tell that we shouldn't expect this to be a continuing dynamic in the larger economy; going from 1.0 to 1.6-1.7 in roughly 25 years (roughly a 2% clip) when the underlying is only increasing in industrial demand dictates a pretty strong signal that prices will continue to march back up.

Finally to add to the pain, the most important commodities (industrials and energy) also happen to be the most cyclical/beta correlated. Basically, we will be paying higher and higher prices for important commodities that reflect a world getting rich faster than what we are actually experiencing. 

Given that we have covered why the US may not be in the strongest position coming out of the contagion, it seems painfully obvious that there will be other countries that are better poised to put up the big growth numbers. That delta will be very painful to the US economy.

CONCLUSIONS

Ok, so we know the US economy is going to be running on fumes and commodities are going to get expensive - so what? Both messages have been tossed off the cuff by numerous talking heads but looking at it analytically and then combining the two leads to a very scary picture of what's in store. More specifically, the lab rats at ZH headquarters are now working on thinking about what price level action is going to look like, and what that implies for us as citizens first and investors second. We want to caution that this is more complicated than it initially seems as the kneejerk reaction to "commodity price shock" is "stagflation" - however, it would be short sighted to toss out that old chestnut without taking into account the massive market manipulations and macro shifts we have seen. 

As always, we welcome thoughts, comments, feedback, opposing publications. Additionally, any (good) pieces on price action movement/CPI predictions would be greatly appreciated - cornelius@zerohedge.com

Many thanks to David Rosenberg and GS for data

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Don't fall into the equity trap for oil

Lately, oil has been closely tracking the equity markets - most recently, it closed down for a second straight session (after a high of 54.66, just short of our band at 55) on the back of a poor day in equities. We believe this makes no sense as we think that oil needs to respond more directly to aggregate demand (as we've discussed before) instead of using the equities market as a proxy for aggregate demand. 

Tracking equities as a real time demand proxy may make sense in normal times when demand is dictated on the margin and capital structures and credit markets are operating within a familiar band. However, these days the macro factors will continue to drive the long-term trends (see the minimal reaction to OPEC shifts, collapse in Baltic Dry, dismal export numbers globally). To that end, every false equity driven "recovery" is bound to get smacked back down until the fundamentals are fixed.

Eventually, oil is going to decouple from equities and when it does it's going to break long faster than equities. We'll cover the specific macro factors that need to be addressed and consequently will serve as important indicators for an oil recovery in another post.

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Oil prices and aggregate demand

Oil closed out the month on a down slope, tumbling on the strengthening of the dollar and a weaker outlook for equities. On a larger scale, the story with oil over the part 3 months or so has been the larger macro forces completely overwhelming the oil-specific supply and demand issues. For example, the market has largely been unresponsive to OPEC's desperate attempts to prop up oil prices; currently, it's estimated to be running under capacity by ~6MM barrels. A lot of oil traders believe that OPEC won't be able to hold themselves to their production cuts and the rest believe that the macro-imposed demand constraints are a much stronger force. As an example of these macro demand shocks, it would be good to look at our posts on Japanese demand and dry shipping.

ZH believes that the oil market is following the lead of the other major markets and is overestimating the probability of a recovery in a relatively current timeframe. Here is the May 09 West Texas crude contract over the past month:

Given the basis on oil has been pretty negligible recently, this is a good contract to track. Going forward, oil is going to continue to be driven by the strength of the dollar and the short term outlook for equities. As we believe that we aren't anywhere close to being out of the woods, it's unlikely for spot oil and near contracts to go much higher than the $55 level.

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