We continue keeping you informed on the results of our activities, and the IFC specialists’ take on the situation and the processes in global and regional economies.

In November 2017, the value of assets of the WellMax investment portfolio increased by 0.97% in USD in EUR, which is equivalent to 12.28% per annum with monthly compounded interest. There was a 13.88% yield per annum in rubles and a 12.32% yield per annum in yuans with monthly compounded interest.

The value of assets of the WellMax Premium investment portfolio decreased by 14.68% in USD over the period from November 10, 2017 to December 10, 2017.

Last month's decrease in the WellMax Premium portfolio asset value is temporary in its nature, and is caused by price fluctuations in the US natural gas market.   

Last month's decrease in the WellMax Premium portfolio asset value comes is a result of highly volatile prices of the US natural gas market. As we had pointed out in previous economic reviews, natural gas is a seasonal commodity, whose price heavily depends on the reserves, the balance of supply and demand, and the weather in the mainland US during winter heating season.

The combination of the factors affecting the market in mid-November, which was covered in the previous economic review, was highly positive for natural gas prices:

- the early start of the winter heating season, which the USA entered with the lowest level of natural gas reserves over the last three years;

- a drop in temperature expected for the late November in the regions, considered to be key in terms of natural gas consumption (the East Cost of the USA and the Great Lakes).  

On top of that, Louisiana's Sabine Pass LNG Terminal export loads hitting record high, as well as Maryland’s new Cove Point LNG Terminal (scheduled to start exporting in late December 2017/early January 2018), served as additional causes for optimism.

However, U.S. natural gas price started to decline in late November. The gas price drop came as a surprise for us, as well as many other players in the market, since it went against the above-mentioned fundamental factors operating in the market, and this in the absence of any newsbreak.

The most likely reason for the drop was extensive hedging of gas prices by the producers. The natural gas price of 3.2-3.3 USD per million BTU (as it was at the time of the last economic review) was convenient for gas producers; in order to keep that price in between seasons, when the spot price typically falls, companies started hedging, i.e. selling the unrealized gas on the stock market.

There were two reasons for such large-scale hedging. The first was the desire of producers to sell unrealized gas more profitably before the U.S. Federal Reserve raise the interest rate. The second was the desire to hedge their gas prior to Catholic Christmas, thus protecting themselves against possible price volatility of late December, when the stock exchange is closed due to the holidays.

Nonetheless, it should be noted that that this factor is short-term in its nature, and, in our opinion, is to peter out by late 2017. In turn, as hedgers leave the market, this should result in the reverse of the price trend, and renewed growth of gas quotes and the UGAZ etf respectively. The significant drop of temperature, which is expected on most of the territory of the USA, should also add to the price growth.    

Considering the short-term nature of the price drop in the gas market, not only did we not sell this asset, but in fact, increased our investment. At the same time, many private investors, having no time/opportunity to analyze the situation properly, gave in to panic, and started to close their positions at low points, where many of them suffered substantial losses of 30%-50%. This example underlines the advantage of the WellMax products: we help private investors avoid wrong decisions in stressful situations, thus insuring them against possible financial losses. 

The drop of gas prices also adversely affected stocks of shale companies represented in our portfolio. However, unlike gas prices, which are highly volatile and heavily depend on temperature fluctuations, gas companies, such as Southwestern Energy Company and Gulfport Energy Corporation, have good opportunities for growth with current prices, due to the following reasons: 

Firstly, stocks of the issuers chosen for our investment are undervalued with the current gas prices, due to a number of factors, such as the market capitalization/net profit to assets ratio, the difference between sale price and cost of production, and so on.

Secondly, the sale price of goods produced by these companies is linked to regional gas prices in the places of natural gas production in North-East of the USA. Due to an existing regional imbalance, the prices in the Marcellus/Utica fields area are significantly lower than the spot gas price in the U.S. south, in Louisiana, which is tracked by gas futures. However, as we have been observing over the last several years, gas transportation infrastructure is developing rapidly in the North-East of the USA, which is going to result in a narrowing gap between regional gas prices. This will occur due to the transfer of the excessive Marcellus/Utica gas volumes to regional markets, such as the Gulf Coast of the United States, Mexico, etc., which have higher costs. Furthermore, as a result of this reduction of price difference, gas prices are going to increase in the area of the Marcellus/Utica fields, even if they drop in the south of the country. This will positively affect the sale price of products of the shale companies in our portfolio.

Last month, the oil market also showed considerable volatility, while oil prices fell neatly within the range that we had outlined in the previous economic review.

As we forecasted in the October economic review, positive news environment and the certainty by market participants that OPEC+ global oil pact was about to be prolonged, kept the oil prices high, allowing them to settle at 63-64 USD a Brent barrel, with the Vienna meeting of ministers coming up on November 30th.

Following the announcement by the participating countries of the long-expected decision to prolong the oil pact by 9 months (until the end of 2018), the oil market showed a slight correction due to profit taking of market participants after the Vienna meeting, as well as the US oil production growth figures coming into the spotlight.

According to the latest data from the US Department of Energy, the country's oil production, which has been rising for nine weeks in a row, has reached the record high 9.789 million bpd, as seen on the chart below.  

It is also worth noting that oil production level in the US not only approached the levels of Russia and Saudi Arabia, but also neutralized most of OPEC efforts. For instance, according to OPEC monthly reports, despite its best efforts, from December 2016 to the late November 2017, the cartel managed to decrease its output by only 581 thousand bpd. This was due to a significantly increased production level in Libya and Nigeria, who had been excluded from the agreement, as we mentioned it in previous reviews. Oil production in the U.S. rose by 1.01 million bpd over the same period, which is almost double the cartel's reduction.  

At the same time, it should be mentioned that total stocks of the countries in the Organization for Economic Co-operation and Development (OECD), which is the key factor for the cartel, has fallen by 202 million barrels since the beginning of the year, which can be seen on the graph below (source: OPEC Monthly Oil Market Report).

Despite the fact that the stock level is still 137 million barrels above the average over the last five years, the reduction of the stock, demonstrated above, indicates the success of OPEC+ agreement and the current market balancing.

Oil prices received more short-term support from the data released on Friday, December 8th, by the Chinese customs service. It reported a growth in oil import to China in November, to 37.04 million tons (9.01 million bpd). Overall, over the 11 months of 2017, the country has imported 386 million tons of oil, which is 12% more than the January-to-November figure from the previous year. Price growth increased on Monday, December 11, amidst the news reports surrounding the North Sea oil delivery shortage, caused by Forties Pipeline System breakdown.   

The US DOE released statistics on changes in the country' commercial stocks of oil, which revived the growth of oil prices after a period of corrections. Thus, according to the latest information, over the last five weeks U.S. oil stocks decreased by 22.51 million barrels, instead of 14.78 million barrels expected by the market, which can be seen from the graph below.  

Despite the fact that these changes of oil stocks were caused by the recently changed import/export balance in the US (as we expected it in previous economic reviews), a significant difference between the real uptake of oil and market expectations entailed a strong growth of oil quotations.

News from Libya also contributed to the growth of oil prices, as on Tuesday, December 26, armed men blew up one of pipelines carrying crude oil from the Marada oil field to Libya’s largest oil port Es-Sider. This will result in a decrease of Libya's oil production by 70-100 thousand bpd, as estimated by the pipeline operating company.

Considering the fact that the above-mentioned pipeline breakdowns are temporary in their nature, we cannot rule out a possibility that oil prices will slightly decrease in the nearest future.  At the same time, we should consider the 2017 trend of stabilization of supply and demand in the oil market (as evidenced by the decrease in the OECD total oil stocks), as well as the prolongation of OPEC+ agreement with the participating countries, which are in need of higher oil prices for budget balancing.   

The taxation period and soaring oil prices strengthened the ruble, but the significant risks for the national currency remain.

Another factor strengthening the Russian national currency was positive price dynamics in the oil market. Furthermore, the taxation period factor also contributed to the growth of ruble. This is because, prior to the tax period, exporters sold their reserves of foreign currency in order to pay severance taxes.  

As the oil price soared in the fourth quarter and remained at this level, we believe our spring 2017 forecast of gradual decline of the Russian national currency by 10% and more from its value of 56.5 rubles/USD (predicted to occur by late 2017/early 2018), came true in mid-November, when the exchange rate reached 60.4 rubles/USD.

A further significant drop in the Russian national currency seems unlikely with the current price changes in the oil market, especially, considering the pre-election specifics of the current year/ the beginning of the next year. The Russian authorities are likely to try and avoid any noticeable weakening or sharp fluctuations in the national currency.  

At the same time, it should be mentioned that the negative factors and risks outlined in our previous economic reviews, continue to affect and exert pressure on the ruble:

- Gradual narrowing of the gap between interest rates of Russia's Central Bank and the U.S. Federal Reserve System.

On December 13, during the meeting of the Open Market Committee, the U.S. Federal Reserve System increased the base interest rate by 0.25 pp. – to 1.25-1.5%. Furthermore, the Federal Reserve System forecasts three increases of the base interest rate in 2018, by another combined 0.75 pp. At the same time, Russia's Central Bank continued the interest rate reduction – at a meeting on December 15 it decided to cut the base rate from 8.25 to 7.75% per annum. As a result of this narrowing difference between the rates

(https://internationalfinancialcommunity.com/1531-march-2017)

- Toughening sanctions  

As Michael Flynn, the former National Security Adviser to Donald Trump, pled guilty to giving false testimony to the FBI and to having contacts with Russia at the President circle's behest, the risk of new sanctions from America increased dramatically. As we mentioned it in the previous economic review,

(https://internationalfinancialcommunity.com/1613-october-2017)

Another issue to take into account is the Russian Ministry of Finance's increased purchases of foreign currency. Throughout December, 2017, the Ministry of Finance had planned to purchase foreign currency in the record high amount of 203.9 billion rubles. To compare, foreign currency intervention in the previous month had amounted to mere 123 billion rubles. Overall, according to the Russian Ministry of Finance, at year-end 2017, the amount of additional oil and gas industry revenue spent on buying foreign currency in the domestic market will amount to 829.1 billion rubles. At the same time, the Head of the Ministry of Finance announced that next year the Ministry might spend around 2 trillion rubles on buying foreign currency, provided Urals oil prices stay at $54-55 per barrel, which will exert more pressure on the ruble.

EURUSD: Trump's tax reform is to boost the dollar's growth in the long-term.

Last month the EURUSD currency pair showed significant price fluctuations as well. On November 24, the common European currency reached the level of 1.1930 against the U.S. dollar, amidst the release of the controversial minutes of the Fed's November meeting, and the positive statistic data from the Eurozone. However, the euro failed to maintain this position, and the rate returned to the 1.14 – 1.19 range, which we had outlined in the previous economic review.    

As mentioned in the previous economic review, further changes in the EURUSD currency pair will heavily depend on the Congress' decision regarding Trump's tax reform. In this context, it should be said that both chambers of the U.S. Congress passed the tax reform plan, which was later signed by President Trump on December 22.

No doubt that the passed tax reform bill is going to affect the U.S. dollar positively, for the following reasons:

- The recovery of trust into the U.S. political system, and Trump personally.

The bill’s approval became Trump's first big victory, following several failed legislative initiatives. It also marked a reconciliation between the Republican Party and its new leader.  

- Economic growth acceleration & return of capital

Among provisions of the President's tax reform there is the tax rate cut for corporations to 20% from the current 35%. Such a significant tax cut may result in the return of capital, which will be converted in dollars. At the same time, tax cuts may boost the US GDP growth, forcing the Fed to speed up the interest rate hike.

- More borrowing to bridge the budget deficit

Tax cuts are likely to increase budget deficit, leading to increased borrowing, which will contribute to the growth of USD as well.

At the same time, despite the combination of fundamental factors and news, indicating a likely USD growth, Europe's common currency is still strong. It is most likely that the growing dollar trend will become apparent in the first quarter of 2018, amidst the withdrawal of dollar liquidity from the market through the Fed's balance sheet reduction, and US economic boost through corporate tax cuts.

A few words about Bitcoin

With all the fuss surrounding the market of cryptocurrencies, and bitcoin in particular, we would like to point out several important issues without providing any forecast or assessment.  

There are two factors, which have determined the incredible growth of bitcoin as an unsecured asset over the current year. The first one is people's confidence in it, the second is absence of instruments that can decrease its cost, i.e. short positions.   

In this context, we should mention that on December 11, bitcoin futures trade was launched at the Chicago Option Stock Exchange (CBOE), and on December 18 CME Group Inc., the world's largest market of financial derivatives, also started trading bitcoin futures. The launch of Bitcoin futures is important, as it provides institutional investors with a necessary tool for legal and safe work in the cryptocurrency market, as well as the way to open short positions on bitcoin.

Considering the rapid growth of bitcoin and absence of any significant correction over 2017, as well as the skeptical attitude of the “big business” towards cryptocurrencies, we cannot exclude the “bear scenario”, in which professional investors will push the price of bitcoin down.

In general, the bitcoin futures are likely to flatten out the price and decrease its volatility over short time periods (hours, days) through increased market liquidity, simpler functioning of the exchange offices, lower fees for converting cryptocurrencies into fiat money, and through reaching a balance between the bulls and the bears.

However, late December's bitcoin crash, in our opinion, is mostly caused by speculative cryptoinvestors massively selling this asset before Christmas and New Year's holidays, rather than the introduction of futures.

According to our analysts, the positions opened by IFC, including the long gas positions, are likely to grow in the two following months. Thus, we forecast a significant growth of assets by the end January/February, 2018, which we are sure will pleasantly surprise the investors and partners of International Financial Community!

 

Sincerely yours,

IFC team