If copper is considered to have a PhD in economics (for its status as a global barometer of the state of economic activity), the recent gyrations in crude oil in response to global conflicts should give it the title “the commodity with a PhD in international relations.”While stocks and the Euro where engulfed in turmoil, crude oil has quietly crept up 37% from lows at $75 per barrel, to $102 per barrel, in roughly one and a half months.
Various media sources have been baffled by this and have attempted to attribute it to “economic growth”, or tight physical supplies of crude oil. While the latter is probably more accurate, the real reason behind crude oil’s intense strength is reminiscent of last fall and winter’s uprisings in the Middle East.
While stocks and the Euro where engulfed in turmoil, crude oil has quietly crept up 37% from lows at $75 per barrel, to $102 per barrel, in roughly one and a half months. Various media sources have been baffled by this and have attempted to attribute it to “economic growth”, or tight physical supplies of crude oil. While the latter is probably more accurate, the real reason behind crude oil’s intense strength is reminiscent of last fall and winter’s uprisings in the Middle East.
In December of 2010, protestors in Tunisia embarked on an eventually successful overthrow of their authoritarian regime. Egypt followed in their footsteps and Libya had the latest dictator toppled by fed-up citizens.
All the while, crude oil was in a frantic rally toward $115 per barrel as traders and hedgers priced in serious consequences to oil-producing countries such as Saudi Arabia, Iran, and other OPEC nations.
The danger was that oil-producing governments in the Middle East would topple, along with the capacity to pump oil, and supplies of the commodity would drastically tighten, thereby driving up the price.
So when looking at the current rally, our immediate reasoning for it would not be any particular economic growth story. Chinese year-on-year GDP has been in a drop off for most quarters since 2010, and inflation has also been scaled back to a current 5.5%, from a high of 6.5%, by PBOC efforts to prevent an uncontrollable asset bubble formation.
The economic statistics from other major oil consumers, such as the United States and Europe, probably do not need re-hashing since the daily stock market sell offs tell that story better than we can.
So if there aren’t strong fundamental reasons for strong oil, what could be causing the renewed rally?
It is worth recalling the winter of 2010 when similar questions were being raised by the media and financial personalities. Eventually the story that received the most traction (when Tunisian and Egyptian governments were ultimately toppled) was that fear and expectations played more of a role, and higher oil prices signified the higher risk premium that comes with a sudden shock in oil supply.
Figure 1 shows the most recent tear higher in WTI Crude Oil for December, 2011 delivery (orange line). This rally got its start in the beginning of October, a time when European officials were battling to agree on a 50% haircut in Greek debt. This caused most assets to rally, but since then oil has outperformed stocks and the Euro.
Isolating our analysis solely to crude oil, there is a quite apparent tendency for crude oil to rally during (and leading up to) uprisings in the Middle East.
The daily crude oil chart in Figure 2 shows popular uprisings occurring over time marked by red-shaded areas. The yellow lines also span the conflicts, from beginning to end, and are labelled according to the specific national uprising.
The three outbreaks of conflict last winter essentially helped oil break out of a $92 resistance level and rally for more than 4 months.
This month’s decoupling of oil from other risk assets, could be foretelling skittishness over recent events in Iran and Syria (where a growing chorus is calling for action against Assad’s brutality), and even over today’s report from the AFP that thousands of Kuwaitis stormed parliament after demanding the prime minister’s resignation.
Additionally, borderline hostile rhetoric towards Iran after a recent explosion at a missile base is putting more focus on their tensions with Israel; defence Minister Ehud Barak was quoted as wishing for more explosions of this type.
Finally, we turn our attention to one more ‘decoupling’ of an asset that should track crude oil (with a negative correlation).
This asset is the US Dollar versus the Canadian Dollar, which normally depreciates during rallies in oil. This is because the Canadian economy benefits from higher oil prices due to its large crude oil exports.
During the same period that oil has climbed, USD/CAD has climbed when it should have declined on an appreciation of the Canadian dollar. This period begins around November 1st. We believe this actually reinforces our stronger US Dollar outlook because we are seeing the US Dollar outperform the Canadian dollar even in the face of strong oil.
We take note of the light grey trend lines in Figure 3 which show the inverse correlation to Crude Oil Futures (in Figure 2). The exception occurs during the current rally in both assets, which starts around November 1.
With this in mind, our broader outlook is for appreciation of the USD against especially weak currencies such as the Euro, but also gradual appreciation against stronger currencies such as the CAD and AUD.
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