Monthly Market Monitor

"Backwardation" is a futures market term whose origin dates back to the mid-19th century in England. Its simple definition describes a condition in the futures market whereby future prices are cheaper than current, or "spot," market prices. In other words, the future oil prices are now inverted and downward sloping, a condition that was created for the first time during May of this year. Often times, this condition is viewed by economists and analysts as abnormal, usually signaling a future easing in prices. Consider for example, the current breakdown of future prices for light sweet crude (1,000 bbls, $ per bbl) as listed on the Chicago Board of Trade, May 29th 2008.

July 2008	$131.03
August 2008	$130.99
September 2008	$130.77
December 2008	$129.96
December 2009	$127.78
December 2010	$127.06

During times when normal conditions exist between supply and demand, prices will generally be higher the longer date is in the future. Explaining this is simply the "time premium" that is involved when future delivery is expected on a commodity and the luxury of locking in that future price with an uncertain or supply short commodity. This is often especially the case with oil during this period due to "seasonality," a condition of higher future prices that reflects the likelihood of higher demand during the winter months when oil is often more scarce. For some reason today, however, prices are now inverted reflecting "backwardation" and both economists and professional traders are pointing to this condition as a sign that perhaps finally prices will begin to ease. This condition can reflect that perhaps there is an excess of supply or simply that prices have gotten too far ahead of themselves. With recent supply pressures coming from Nigeria, Iraq and Russia, many economists have been pointing to a speculative premium in the oil market that may explain as much as $30/bbl over what is considered to be fair value. As this premium gradually dissipates from the market, many expect oil prices to head south towards levels that are closer to $100/bbl, something that the futures market may now be supporting. This may also bode well for the stock market because high oil prices have generally held equity prices hostage as the cost for economic growth has become significantly more expensive. Certainly, as with any momentum or speculative driven commodity market like oil, high prices appear to be here to stay long term but, near term, the condition of "backwardation" may finally signal that prices have gotten ahead of themselves.

Treasury yields broke 4% for the first time since early January on fears that economic growth and inflation pressures are continuing. Many economists are predicting that the global economy is entering into a period of "stagflation," a period often characterized by lower growth but higher inflation. This condition may also be compounded by the current credit crunch which is limiting both lending and future economic growth due to the troubles within the financial/banking sector. This month it has also been rumored that Lehman Brothers may be facing similar pressures as Bear Stearns, and there are signs that hedge funds and others may be reluctant to enter trades with the investment banking entity. Initial durable goods data pushed Treasury yields over 4%, even though it alleviated earlier fears of a protracted recession. This data also bolstered speculation that the Fed may start raising interest rates by year end in order to control inflation during a period when economic growth is showing signs of improving. Overall, investors have shown a willingness to take on more risk during the month of May, and this shift has given a lift to other riskier assets such as corporate or high-yield bonds. Generally, this shift has been at the expense of risk-adverse asset classes such as Treasuries, which were showing signs of strong demand during the credit crunch period. On a go-forward basis, Treasury yields should trend higher as economic growth continues and the likelihood of a protracted recession appears remote. Once again, the U.S. stock market's forward-looking nature should reflect higher prices as the recession risk appears to be fading.

Prepared by:
Robert J. Garland, MBA
Vice President
Research Department, ING Advisors Network

1. Wall Street Journal 5/31/2008

The views are those of Robert J. Garland, MBA, Vice President, Research Department, ING Advisors Network, and should not be construed as investment advice. All information is believed to be from reliable sources; however, we make no representation as to its completeness or accuracy.

All economic and performance information is historical and not indicative of future results. The market indices discussed are unmanaged. Investors cannot directly invest in unmanaged indices. Please consult your financial advisor for more information. Additional risks are associated with international investing, such as currency fluctuations, political and economic instability, and differences in accounting standards.