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A Note on the Iranian Energy Infrastructure

(March 21, 2010)

Dear Subscribers and Readers,

Let us begin our commentary with a review of our 9 most recent signals in our DJIA Timing System:

1st signal entered: 50% short position on October 4, 2007 at 13,956;

2nd signal entered: 50% short position COVERED on January 9, 2008 at 12,630, giving us a gain of 1,326 points.

3rd signal entered: 50% long position on January 9, 2008 at 12,630;

4th signal entered: Additional 50% long position on January 22, 2008 at 11,715;

5th signal entered: 100% long position SOLD on May 22, 2008 at 12,640, giving us gains of 925 and 10 points, respectively;

6th signal entered: 50% long position on June 12, 2008 at 12,172, giving us a loss of 1,430.02 points as of yesterday at the close.

7th signal entered: Additional 50% long position on June 25, 2008 at 11,863, giving us a loss of 1,121.02 points as of yesterday at the close.

8th signal entered: Additional 25% long position on February 24, 2009 at 7,250;

9th signal entered: 25% long position SOLD on June 8, 2009 at 8,667, giving us a gain of 1,417 points.

According to the Energy Information Administration (EIA), Iran's refining capacity as of today is around 1.5 million barrels a day.  The following table shows Iran's nine refineries , as well as the refining capacities of each of them:

Iran Crude Refining Capacity, 2009

Unfortunately for Iran, its oil consumption is approximately 1.7 million barrels a day.  In addition, Iran has a limited amount of light fuels refining capacity – meaning that the country has to import a substantial amount of its gasoline supply.  Because of this reliance, Iran is nowhere close to being energy independent, although the country is making a concerted effort to do so sometime in the next 3 to 5 years.

Firstly, there is no question that Iran has substantial amounts of crude oil – its daily production of 4.2 million barrels a day is second only to Saudi Arabia and has the capacity to satisfy two and a half times the amount of domestic consumption. In addition, Iran no doubt still has much dormant supply.  For example, the country – at its peak in 1978 – produced over 5 million barrels a day.  Since the 1979 revolution and the Iran-Iraqi War, many of the country's oil wells have suffered from a lack of investment.  Iran currently has five upstream projects in the works (as shown in the following table) – all of which should bring an extra 180,000 barrels a day in production by 2015. 

New Iranian Upstream Crude Projects through 2015

Secondly – and more importantly – Iran also currently has plans to increase its total refining capacity from 1.5 million to 3.0 million barrels a day by 2013.  This would be accomplished by the combination of expansions at current refineries as well as construction of new refineries.  Iran has also discussed setting up joint ventures to accomplish this goal with countries such as China, Indonesia, Malaysia, and Singapore.  Finally, in order to discourage wasteful gasoline consumption, the Iranian Guardian Council has adopted plans to eliminate its infamous energy subsidies by the year 2015. 

From an economic and strategic standpoint, Iran must realize that it needs to be at least energy independent in order to not only secure (or try to secure) the country's security – but the government's hold on power as well.  Given Iran's track record (or lack thereof) of investing in its energy infrastructure, I have my doubts as to how much of this could be accomplished in the coming years.  However, building additional refining capacity is much easier than finding new sources of recoverable oil – over the next five years, I thus expect Iran to increase its oil refining capacity by a substantial amount.

Let us now discuss the most recent action in the U.S. stock market via the Dow Theory.  Following is the most recent action of the Dow Industrials vs. the Dow Transports, as shown by the following chart from January 2007 to the present:

Daily Closes of the Dow Jones Industrials vs. the Dow Jones Transports (January 1, 2007 to March 19, 2010) - For the week ending March 19, 2010, the Dow Industrials rose 117.29 points, while the Dow Transports rose 48.38 points. Any way one looks at it - the market is very overbought. Since the February 8th bottom, the DJIA has rallied 8.4% while the Dow Transports has rallied 15.3%. In addition, the Dow Transports has now risen 6 weeks in a row. Given the short-term overbought condition of the market, there is a good chance that the market will correct as soon as this upcoming week. Moreover, there are still lingering troubles in the European banking system, the U.S. commercial real estate market, and the tightening Chinese central bank. However, given the decent momentum and valuations in the U.S. stock market - the cyclical bull trend that began in early March 2009 remains intact. For now, we will maintain our 100% long position in our DJIA Timing System.

For the week ending March 19, 2010, the Dow Industrials rose 117.29 points, while the Dow Transports rose 48.38 points.  Despite the fact that both the Dow Industrials and the Dow Transports made new bull market highs (thus extending the bull market much further per the Dow Theory), there is no doubt that the market remains highly overbought.  The rally from the February 8th bottom has simply been relentless, with the Dow Industrials rising 8.4% and the Dow Transports 15.3% since that time.  While the Greek fiscal crisis is now dying down, I still expect the global equity markets to consolidate further, given the overbought conditions in global equities.  My guess is that any upcoming consolidation will last anywhere from 2 to 6 weeks.  However, given the strong momentum from the early March 2009 lows – and combined with decent valuations, strong liquidity, and strong upside breadth – there is no question that the cyclical bull market is intact.  We will maintain our 100% long position in our DJIA Timing System.

I will now continue our commentary with a quick discussion of our popular sentiment indicators – those being the bulls-bears percentages of the American Association of Individual Investors (AAII), the Investors Intelligence, and the Market Vane's Bullish Consensus Surveys.  The latest four-week moving average of these sentiment indicators rose from a reading of 11.5% to 13.3% for the week ending March 19, 2010.  Over the last four weeks, this reading has made a stunning advance – rising from just 4.9%.   Following is a weekly chart showing the four-week moving average of the Market Vane, AAII, and the Investors Intelligence Survey Bulls-Bears% Differentials from January 1997 to the present week:

For the week ending March 19, 2010, the four-week MA of the combined Bulls-Bears% Differential ratios increased from a reading of 11.5% to 13.3% - its most overbought reading since early February. The latest rise in bullish sentiment suggests that the rally is again vulnerable to a short-term correction, especially given the overbought nature of the market. For now, however, we will maintain our 100% long position in our DJIA Timing System.

After rising from 4.9% to 13.3% over the last four weeks, this reading is now again approaching overbought levels.  Because of this rise in bullish sentiment, I expect the market to consolidate further (it takes time to work off the bullish sentiment) – one that could extend to mid or even late April.   However, given the amount of cash on the sidelines, strong liquidity, and decent valuations, there is enough "pent-up demand" for a decent rally starting in late spring and summer of 2010, and probability suggests that we will end 2010 with a new cyclical bull market high.  For now, we will remain 100% long in our DJIA Timing System, as we believe the cyclical bull trend that began in early March 2009 remains intact.

I will now close out our commentary by discussing the latest readings of the ISE Sentiment Index.  For newer subscribers, I want to again provide an explanation of ISE Sentiment Index and why it has turned out to be (and should continue to be) a useful sentiment indicator going forward.  Quoting the International Securities Exchange website: The ISE Sentiment Index (ISEE) is designed to show how investors view stock prices. The ISEE only measures opening long customer transactions on ISE. Transactions made by market makers and firms are not included in ISEE because they are not considered representative of market sentiment due to the often specialized nature of those transactions. Customer transactions, meanwhile, are often thought to best represent market sentiment because customers, which include individual investors, often buy call and put options to express their sentiment toward a particular stock.

When the daily reading is above 100, it means that more customers have been buying call options than put options, while a reading below 100 means more customers have been buying puts than calls.  As noted in the above paragraph, the ISEE only measures transactions initiated by retail investors – and not transactions initiated by market makers or firms.  This makes the indicator a perfect contrarian indicator for the stock market.  Since the inception of this index during early 2002, its track record has been one of the best relative to that of other sentiment indicators.  Following is the 20-day and 50-day moving average of the ISE Sentiment Index vs. the daily S&P 500 from May 1, 2002 to the present:

ISE Sentiment vs. S&P 500 (May 1, 2002 to Present) - After declining to its lowest level since late November 2008 just three weeks ago, the 20 DMA has turned up dramatically, and is no longer at an oversold level. Moreover, the 50 DMA is also in the midst of turning up. While this latest move suggests that the bull market remains intact (sentiment reversing from an oversold level is always a bullish sign for the stock market), it does not preclude the market from experiencing a short-term correction. For now, however, we will remain 100% long in our DJIA Timing System.

For the week ending March 19, 2010, the 20 DMA rose from 114.3 to 120.5.  With the bounce over the last three weeks, the 20 DMA is no longer at an oversold level.  While the latest reversals in both the 20 DMA and the 50 DMA are a bullish sign in the longer-run, I still expect the market to consolidate over the next few weeks, given the overbought nature of the U.S. stock market.

Conclusion: Over the longer-run, Iran will continue to be a “problem” for the U.S.  For the Iranian government to have a chance at securing its borders or its powers over the country, the most cost-efficient way would be to build out its refining capacity.  Ironically, this increase in refining capacity in Iran will put less pressure on global refining capacity in general – and will thus act as a damper on global gasoline prices in times of relative geopolitical calm. 

As for the current state of the U.S. stock market, I continue to expect at least a consolidation phase given the overbought conditions in the global stock market.  Even though the Greek fiscal crisis is over for now, the overbought conditions and the lack of a serious correction since early March 2009 suggests that the consolidation phase will probably last for a longer while.  Should the market experience a deep correction, subscribers should note that there is strong support for the Dow Industrials in the 9,500 to 9,800 range.  However, we maintain that the U.S. stock market is still in the midst of a cyclical bull market – and thus we remain 100% long in our DJIA Timing System.  Subscribers please stay tuned.

Signing off,

Henry To, CFA

 

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