Reading between the Lines

A few days ago, the story broke that mighty Goldman Sachs, who over the last year told its clients to be long oil and oil related securities reversed its recommendation and told those clients to sell and take profits. There are several possible potential stories here.

One is whether GS let it be known to all of its clients at the same time or whether it told its biggest (best) clients first. The sell-off did start before the news was reported by TV. 

Another possible story is whether GS is putting forth a legitimate sell recommendation or if it is just trying to generate selling interest because it wants to be a buyer at a lower level which I think, but cannot prove, it has done before.

These are potential stories that might attract the attention of regulatory agencies especially since a senate panel is claiming that GS mislead congress and their clients.

They are interesting stories to be sure but there is another that I would like to discuss.

The story I want to hypothesize is the deeper statement GS may be making. There is a much more significant insinuation here than the seemingly large statement calling for a top in oil here when only a year ago they saw oil going to $200 a barrel. How and why would Goldman suddenly change its target price in oil to here and now, just about half-way to its previous $200 a barrel target and what is the deeper, larger message?  

Let’s assume GS is seriously trying to give legitimate advice that they truly believe in. If they truly feel that oil has peaked and an ensuing sell-off (not just a little pullback) is coming, then they are saying that the recovery is going to fail! It is that simple. Think about how things were when oil peaked before. At that time, US demand was definitely higher but so was the US dollar. The falling US Dollar which sends oil prices higher can offset the lower US demand to some extent. But today the incredible growth in China and its future implications should send oil prices much higher. We have all witnessed the meteoric rise in China’s demand for raw materials over the past year with the potential for much more as China enters a phase which I would loosely describe as an “industrial revolution” of sorts.

Knowing China’s continuing growing demand going forward coupled with the assumption that everyone has that the US economy is recovering nicely and thus will create a growing demand for oil, one would expect oil to continue up higher possibly going to that $200 level GS had been seeking.

The only way that wouldn’t happen is if the recovery does not happen in the US, China slows down considerably and Europe sees more debt trouble stifling their recovery. In simpler words, a double-dip global recession.

Let’s all hope this sell recommendation is simply GS trying to draw some sellers so they can go long for the next big up move because if not, we may all be in big trouble!

It’s All in the Numbers

Although this economy has still failed to really create jobs, the unemployment rate has dropped noticeably and surprisingly quickly. The question is how. If you understand how the unemployment rate is calculated you will realize that the improvement is really all in the numbers. It is truly miraculous how the calculation seems to always make the unemployment number better than it actually is and how this calculation/manipulation makes it tough for the unemployment number to increase quickly but very easy for it to decrease easily. It is almost as if someone set up the calculation to be that way.

Let’s take an example using some smaller and more manageable numbers. First, we need to have a workforce size. This is the where we can play some real games! But, we will simply start with a workforce size of 100. Second, we need to have a group of employed people. For our example, let’s say it is 95. Simple math tells us that 95 out of 100 people are employed leaving 5 out of 100 unemployed. Quite simply, we have an unemployment rate of 5%.

We have two movements to analyze….an increase in the unemployment rate, and a decrease in the unemployment rate. We will start with the recession hitting. Of our 95 employed people, 5 of them lose their jobs leaving only 90 people employed. Simple logic tells us that there are now 10 people unemployed out of our 100 person workforce. The unemployment rate must now be 10%, right? Not so fast! There is a little trick here that the government employs. The government changes the workforce size. The government says that of the original 5 unemployed people, 3 of them have been unemployed for a length of time that suggests that these 3 people must no longer be looking for (willing to) work. The definition of the workforce is those able and willing to work. Now, with the government declaring those 3 workers no longer willing to work, the workforce is lowered to 97 people…..of which 7 are unemployed. Suddenly, the unemployment number which we know is 10% is officially stated at only 7.2%

The government controls the size of the workforce by controlling the time limit for a person to find work before that person is considered not looking and is thus taken out of the workforce. As you can see, this can go on and on and as more and more people who have been laid off take longer and longer to find another job, the more people that can ultimately be subtracted from the workforce keeping the unemployment rate manageable. So, you can see just how hard it is to increase the unemployment rate significantly while in reality a greater number of people remain unemployed.

Now let’s suppose that the recession is over and firms begin hiring again. Currently, our workforce is at 97 people of which 7 are unemployed leaving 90 people employed. If, of the 7 unemployed, 3 get jobs, then we still have a 97 person workforce but only 4 are unemployed giving us an unemployment rate of only 4.1%……a huge improvement albeit for us in the know, an aberration.

Even if the 3 newly hired people came from outside the defined workforce, we would still have only 7 people unemployed out of a now, once again, 100 person workforce creating a 7% unemployment rate Now, compare this situation of the 7 people unemployed versus the 7 people unemployed three paragraphs above, we see we have the same amount of people without jobs (7) but there is now a difference in the unemployment rate (7.2% versus 7.0%). You can plainly see that the unemployment rate is a “creative number” that can be massaged by the government through the calculation to increase slowly when job losses are occurring and decrease quickly when job growth reignites!