Earnings season is showing many positive signs for the oil industry. The earnings quarter vs quarter show improvements and expenses are down year over year. This good news could help with the explorers over the near term but weakening demand for oil globally could keep the companies in a declining pattern for longer. Fracturing in OPEC's willingness to cut more production and a fracking resurgence in the US should keep a lid on oil prices, and subsequently share prices of oil and gas explorers.

Not all of this should be seen as bad news. A longer term outlook is starting to show the deterioration of production capacity as a result of the cuts in capital expenditures that took place at the end of last year. Oil inventories are decreasing in the US which will eventually result in more volatility in the price of oil during any pick up in demand. The fracking story is also not the same as in the past. While record wells are being dug, there are issues with infrastructure to start pulling oil. Completion and Production revenues from Halliburton's recent earnings release shows the profitability of renting equipment that is in short supply.

​In short the outlook for the macro space is not favoring a surge in oil prices in the near future, but oil service companies keeping growth reigned in through less Cap Ex will be able to weather a slowdown easier than in the past and provide a great entry point for a longer term outlook.  

Crude oil has been struggling to maintain its gains since the start of the year, nearing the lows that it has seen in early March. The rise we have seen in oil was from the OPEC members (and others) agreeing to output cuts to shore up prices. This has faded over time as inventory levels started to creep back up, but not all of this is to blame on the Cartels.

​The US onshore producers have increased production with the rise in oil prices making many of their fields profitable again. This spike in production can stop almost as easy as it started. Longer term, many oil companies are locking in contracts for oil, sacrificing price for stable cash flows. Should this trend continue it could be the start of major oil companies starting to put more of their revenues into longer term offshore projects and exploration.

​This could be a good thing for ETFs like the SPDR S&P Oil & Gas Exploration & Production (XOP), which have been underperforming along with the oil market. As oil contracts get locked in prices and we see a stabilization in prices from a lack of investing in replacement wells, the yield on this ETF could start to justify higher prices in the future.

Today the Fed will most likely raise rates. The markets have priced that into near certainty. What is more important is the message that will come after the increase. The Fed's reaction to the 'reflation' trade spurred by a Trump victory is making assumptions of higher growth and inflation rates in the future. This trade has put the markets at record highs in the US and saw the price of gold driven down by a rising dollar and higher rates in the bond markets. What will determine the trajectory of gold in the coming year will be dependent on the message the Fed delivers.

If the Fed gives into the reflation trade and talks aggressively on inflation threats on the coming year the price of gold will suffer more. The yield curve will flatten as rate increases look to dampen the longer term inflationary prospects of the U.S economy. The more likely case is that the Fed will wait to see if this rhetoric will come to fruition in the coming year and keep an eye on inflation numbers through the first half o next year. If and when fiscal stimulus legislature gets passed you could expect to see more concern from the Fed. In this case the threat of inflation going higher than the nominal GDP rate could spur a drop in the dollar and a rally in gold as a hedge against the potential if negative real rates.

Russia and Saudi Arabia spiked oil up over the weekend with talks of a production freeze. The news has initially spiked the price of oil, but has since seen the price come back down. the oil production freeze talk has lost its potency in the markets since the start of the year as many of the smaller fracking companies have proven more resilient and ramped up production in light of the spring price spike. While not near last years levels the rig count shows that some producers have the ability to increase production in the face of overall lower prices, if they see a rise to the upper 40s in price.

What Saudi Arabia and Russia should really look at in order to raise prices and keep them that way, is the ability for these smaller fracking companies to borrow at attractive rates, making $50 a barrel oil a possibility. So long as frackers can access cheap funds at lower rates the most a production freeze will accomplish is raise the price to start the us shale boom back up.

The Bank of England did not look to increase stimulus or cut rates at this meeting, which many were anticipating. The reaction was a drop in the UK 10yr price, moving yields higher. Across the world we are seeing yields continue to hit record lows and the BoE’s decision to stand pat was the first of expectations of easing not being satisfied. Should the Fed talk alter today be less dovish and Data points for the US and UK are better than the expectations, you could see interest rates start to move Treasuries and even Gilts back towards safe havens. ​

This could have a negative implication on Gold and Silver, where the rise in these metals can be correlated with the dampening expectations of inflation and interest rates over the coming years. To an extent the rise in the precious metal prices are justified, growth across the globe is being revised lower and inflation expectations are going with it. Central banks seem to need to start increasing asset purchases in Japan, the Eurozone, and the UK (depending on data according to the minutes).  As discussed in an earlier post, expectations of longer term interest rates and the price of precious metals will have a higher correlation and any mis-match in expectations could take the wind out of the precious metal rally.​

 Commodities have experienced a good run in the past rally. Oil now above $51 a barrel and gold up about 15% of looking at the GLD. Many macro factors can pay into this trend with China and other markets not having the day of reckoning that seemed so likely even through May. These factors helped commodities off their lows (along side some external shocks in the oil sector) but the dollar cannot be ruled out as a main driver of performance. Fundamentals in oil have not changed in the near term, with OPEC not coming to any agreements at the past meeting. Gold is taking the majority of its cues from the dollar movements this year, with the volatility of the Fed rate hiking decisions providing the majority of those moves.
 
I still believe that the market is underestimating yields and the poor jobs numbers reinforced that bias. As a result I think that the call for gold to continue its accent from this point could be met with some resistance and will need another catalyst to continue higher. More market turmoil could be a cause of this, if there seems to be a spillover into the real economy and the Fed decides to hold off on rate increases over the summer.
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Looking at the current trend in oil it seems that a move back to the lows of the year are a lot less likely. Having moved up 80% from the lows a lot of the oil industry players have seen higher share prices and tightening spreads in the bond markets. While still bullish on the longer term prospects of oil, it could be a good time to take some profits from the more aggressive oil plays in a portfolio or hedge to some degree.
 
The OPEC meeting today is going to show some clues to what the group is thinking but there is little action that is expected. The positions of the countries seem to be entrenched with Saudi Arabia and Iran in a market share dispute and some of the smaller countries like Venezuela and Nigeria in turmoil from lower prices. What is more concerning is the fact that temporary supply disruptions in Canada, Nigeria, and slowing production in Iraq have caused the supply and demand situation to balance out, albeit temporarily. Once these changes to the supply side dissipate you could see some resistance to the upward moves in oil prices. From a stock perspective, anything dividend paying should be held onto because the elevated price will help to ensure a steady payment cycle (perhaps some covered calls would be a good choice for them). Any outright plays in the move in oil prices has most likely seen a good run and should have profits taken while looking for a better entry point in the future.​