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Schork Oil Outlook: Gas Will Cost $3 Sooner Than Later

Stephen Schork, Editor, The Schork Report
Wednesday, 12 May 2010 | 10:21 AM ET

Tuesday, we held a positive outlook for the Small Business Optimism Index and the Wholesale Inventories and Sales report, stating that they would “likely be another round of strong economic news.”

Business optimism for April rose to 90.6%, well above analyst expectations of 87.1% and its highest point since September 2008. This increase more than wipes out the drop seen in March, which was likely due to winter weather and concerns about health care reform, and reflects the gains in consumer confidence.

Meanwhile the U.S. Census Bureau reported strong wholesale figures which boosted the RBOB and heating oil contracts higher despite weakness in crude oil. Total inventories grew by 0.4%, slightly below analyst expectations of a 0.5% increase.

Perhaps more importantly, total sales grew by 2.44%. This was well above the 0.7% increase traditionally seen for this time-step and the largest month on month gain since November, when wholesalers increased trade in preparation for Black Friday and holiday shopping. Total sales are 15.82% above last year and 9.20% above the 2004-08 timestep.

This brings the Inventory/Sales ratio to a low of 1.13, its lowest point on record – i.e. since 1992. This implies that demand is strong and companies should ramp up production even further.

Energy related inventories and sales were strong, but before we discuss the break-down, we thought it necessary to explain why we examine these releases. In an age when traders exclusively track the Euro/USD relationship, or the price of gold or the S&P, it is easy to see a sharp drop and lose sight of the fundamentals. But it is precisely these fundamentals – our total imports, the number of houses sold, the amount of oil in the ground - which affect those currencies and equity indices.

As the Chart of the Day in today’s issue of The Schork Report illustrates, the inventory/sales ratio can be a potent indicator for the S&P 500 index. Not everyone can be Hank Paulson and have the foresight to predict the collapse of subprime debt in late 2007. But anyone looking at the I/S ratio would have seen that a rising ratio meant wholesale demand was dropping precipitously relative to sales despite mixed signals from the equities markets.

The S&P index sold off in December ’07 but appeared to be trending higher by April – boosted by high crude oil prices and China’s hoarding for the Olympics – but the I/S ratio was rising sharply. Between June and August, the S&P index rose by 0.2% (and the bulls assumed everything was fine) but the I/S ratio spiked by 5.7%.

By September, the equities market was crashing lower while the I/S ratio continued increasing. On the recovery, the I/S ratio peaked in January 2009 before dropping in February, implying that demand was returning to the market. The S&P index bottomed the month after, and began rising in March.

It is easy to point out this relationship in hindsight, but it has held for the last year as the equities markets keep rising and the I/S ratio keeps dropping. Thus March’s drop is a bullish indicator for equities and energy demand– and Thursday’s flash splash or blip slip (or whatever the media has dubbed it) was a hiccup, not the start of a bearish trend.

With that out of the way, sales of motor vehicles and motor vehicle parts fell by 2.9% but remain 19.4% above March 2009. Sales of machinery and equipment grew by 2.3%, bringing the year-on-year surplus to 1.9% - a bullish signal fur future demand.

Inventories of petroleum and petroleum products rose by 1.7% while sales of the same grew by 6.6%, a stark contrast to the 2.5% drop in sales seen for the same timestep last year. Current inventories stand 47.8% above last year but sales are 71.0% higher year-on-year. The bottom line is that growth in demand is trumping growth in supplies.

The crude contract is currently in sharp contango, but the stage is set for Wall Street to step in and start bidding higher on the back of China etc. -- as they did in 2008. It has not happened yet, thus The Schork Report maintains our neutral bias, but believe the national average price for retail gasoline will cross the $3.00 barrier sooner rather than later.

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Stephen Schork is the Editor of The Schork Reportand has more than 17 years experience in physical commodity and derivatives trading, risk systems modeling and structured commodity finance.

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