Wednesday, May 18, 2005

Inflation Fears Subsiding, Oil Inventories Soar Again

- The Consumer Price Index for April rose .5% versus estimates of a .4% increase and a .6% gain in March.
- The CPI Ex Food & Energy for April was unchanged versus estimates of a .2% increase and a .4% rise in March.
- Summary of Weekly Petroleum Data for the Week Ending May 13, 2005.
- The EIA reported that crude inventories rose 4.34M barrels versus estimates of a 1.0M barrel rise. Distillate fuel inventories fell 219K barrels versus estimates of a 1.0M barrel rise. Gasoline inventories rose 1.07M barrels versus estimates of a 980K barrel increase.

Bottom Line: Core prices failed to rise for the first time since November 2003. Prices for hotel stays, new autos and clothing actually fell. Energy prices rose 4.5% in April, the largest monthly gain since March 2003, yet the CPI still decelerated from the prior month. This is sending the 10-Year T-Notes yield down 7 basis points to 4.03%. I continue to believe inflation fears have peaked for this cycle and that the CPI will rise less than last year. Over the coming months, look for the media and bears to shift from the “inflation is soaring” argument to “deflation is coming.” This will also prove incorrect.

The price of crude is falling on the energy inventory data. Oil is now down 17.6% from its April 4 highs. However, the contango in the futures market still persists. In my opinion, oil is trading at current levels due entirely to perception, not reality. Commercial hedgers are anticipating an acceleration of crude demand during the fourth quarter from last years’ high levels. Continuing reports of decelerating demand from the US and China, a firmer US dollar and growing inventories will change this view over the coming months. As perceptions change, the contango will begin reversing itself and result in a much sharper decline in oil prices than most expect.


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