Negotiations only serving to buy time

I wonder if they have any roller coasters in Greece. Judging by the ebb and flow of the ongoing debt swap and aid package negotiations, one might conclude they clearly enjoy the thrill of a wild ride. This week, Greek politicians held a series of meetings amongst themselves and with the Troika Committee (the EU, IMF, and the ECB) in an effort to reach agreement on more austerity so Greece can receive its next aid payment. The sad irony of the situation is that the continual delays and missed deadlines have now allowed the Greek economy to worsen to the point that the aid package they are seeking may now be insufficient to meet their needs. I’m not a betting man, but I would wager it unlikely Greece will get more than the planned €130 billion.

By Thursday, a deal was finally announced but it was unclear what the Greeks actually agreed to as details were scarce. Market performance this past week has been at best mixed. Just when investors began to feel comfortable about the outcome, the rug got pulled out from under them and by the end of the week, talks broke down yet again. This time, global stock markets sold off as a reminder to investors that there are still risks in the system.

Aside from Europe, investors kept their eyes on the central bankers this week. Federal Reserve Chairman Bernanke held to his script on how the U.S. economy is improving, but that it was insufficient to materially impact the jobs market. Despite the strong January jobs report, Bernanke did not take the prospect of yet another round of Quantitative Easing off the table during his testimony. Elsewhere, the European Central Bank held rates unchanged with evidence the euro zone economy is showing signs of stabilizing and inflation remains muted. The Bank of England maintained its benchmark interest rate at 0.50 percent, but increased its asset purchase program by £50 billion to £325 billion.

Canadian stocks took direction from commodities which pretty much meant sideways for most of the week. Gold remained range bound within US$1750-$1710 on the week. Oil initially rallied on signs the Greek situation was about to be settled, but later gave back those gains as a deal was not reached. The Canadian dollar traded above parity with the U.S. dollar for most of the week but slid the most in a month to finish the week below par as EU officials demanded more austerity from Greece.

Valentine’s Day almost here

Admittedly, it’s been a slower week in markets but hopefully the rebounding economy will see you buy more chocolates and candy for your sweethearts this Valentine’s Day. The candy industry is anticipating a 4% increase in sales to just over $1 billion this year, the highest since 2008. The higher sales should boost profits for companies including Hershey Co. and Nestlé S.A. According to the National Retail Federation’s Valentine’s Day Consumer Intentions & Actions Survey (you just can’t make this stuff up) the average lovebird will shell out about $126 on everything from jewelry, flowers, cards, and meals. For those of us now feeling ‘below average’, the fact it falls on a Tuesday this year suggests there will be more spent on sweets rather than dinner dates.

Our Recommendation – Don’t leave it to the last moment.

Trading week ahead

The economic calendar, which revs up once again next week, and Euro zone headlines will dictate market direction. In addition to the usual weekly jobless claim data in the U.S., investors will see if the momentum at U.S. cash registers can be maintained with January Retail Sales data on Tuesday. Judging by the higher than expected increase in consumer credit debt (figures out last week), it appears Americans willingness to purchase and to finance those purchases with debt continues. In Canada, December’s Manufacturing figures are not expected to be a needle mover for anyone.

U.S. manufacturing data is on tap for Wednesday with Industrial Production and Capacity Utilization expected to show modest but positive gains. Also on Wednesday, the minutes of the Federal Open Market Committee (FOMC) meeting are released which may give some further insight about the future of monetary policy in the U.S.

Earnings Season turns decidedly Canadian this week with several key Mining, Energy, and Financial names due to report, including Barrick, Goldcorp, Sun Life Financial, and Enbridge. In the U.S., earnings results from Deere & Co. and Waste Management Inc. will be released this week. Both companies are good barometers of the health of the broader economy.

Canadian and U.S. inflation data has been off most investors’ radar for quite some time, but this week’s PPI and CPI data could change that. Prices are moving higher for both manufacturers and consumers due to rising gasoline costs and the fact that in January, farmers saw the sharpest month over month gain in crop selling prices since 1975, suggesting food and energy will contribute to a higher read on the data this month than any month last year.

Question of the week: Shale gas producers have been a victim of their own success. Producers have pursued shale exploration opportunities resulting in unprecedented production growth. At the same time, consecutively warmer winters have resulted in the mother of all supply gluts. The consensus view seems to embrace low gas prices for an extended period. Has this view become too pessimistic?

To answer this question we must look at both the supply and demand side. At current price levels, most producers lose money on every dry gas well drilled. Best-in-class break-even is near $2.70/MMBtu and is making current dry gas production solidly uneconomic. Despite prices below cash costs, there is likely more pain to come. Storage is at its highest level ever, setting up a potentially devastating injection season this fall. We are likely to test maximum storage levels (near 4.0 trillion cubic feet of working gas storage), and potentially we will see gas wells shut in. With current prices below breakeven, rational producers are shifting capital away from incremental new production. In the past three months, we’ve finally begun to see a rig response to persistently low gas prices, as 145 gas-directed rigs have ceased drilling since mid-October. We expect to see the pace of gas rig declines to accelerate, paving the way for a production growth peak as producers respond to prices below production cost by contracting.

From the demand side, nothing corrects low prices like low prices. Since 2000, power generation gas use has averaged 3% compound annual growth, triple the growth rate in electricity demand during that time period. We expect it to continue to accelerate over time, with gas continuing to steal share from coal for power generation. The economics overwhelmingly favor gas-fired generation as the preferred source of power generation supply for the next 5-7 years. The answer to the original question is time frame dependant. Gas prices are likely to remain low well into 2013. However, for patient energy investors, the current risk and reward favors gas especially relative to oil. We find it challenging to contemplate a scenario in which oil prices double on a sustained basis from here, but the potential for gas prices to do so remains plausible.

David Andrews is the Director, Investment Management & Research at Richardson GMP in Toronto. This team of research experts is responsible for monitoring and interpreting economic, geo-political situations, current market environments and trends. @David_RGMP