Oil still pawn in economic recovery

As oil prices hit the lowest levels since July 19, people are starting to realize something I have been saying for a very long time and that is, the price of oil is not acting on its own but is being driven by outside macro-economic forces. I have said time and time again that the price of oil really has been acting as a pawn in the economic recovery and is being driven in large part by economic forces. When the Fed prints more money and the dollar falls and the stock market rises then oil rallies. As the outlook for the economy gets gloomy, like after the Fed meeting last week, stocks fall, then oil gets hit and goes lower. In other words, the fundamentals of supply and demand for oil are dependant totally on the Fed and the prospects for the economy. Of course when I first started to write about these phenomena, it was met by skepticism by a great many people. Some felt that it was a case of the oil market changing because we hit peak oil or was the byproduct of evil speculators. Yet in today's Wall Street Journal, they are writing about what has become so clear to many. The Journal says, "From Houston to New York, energy traders and commodity investors are watching a new and unusual market phenomenon: a persistently high correlation between oil and stocks. Crude oil is now influenced more by the stock market than by its own inventory levels or demand patterns. (Something I have said many times) Lately, that lockstep has reached an extreme, with the correlation between crude oil and the Standard & Poor's 500-stock Index hovering around 70%, doubling the average of 34% since 2008."

The journal goes on, "Oil and stocks aren't supposed to swing in sync with each other. Unlike stocks, which are priced off corporate earnings, oil is usually driven by supply-and-demand dynamics. Since oil started trading in 1983 at the New York Mercantile Exchange, the linkage between the two markets averaged a meager 0.1%. Though there have been sporadic spikes, it has never stayed at such an elevated level for as long as it has lately. The typical low correlation causes many investors to include commodities into their portfolios of stocks and bonds to diversify and smooth out swings in their other investments. Oil and stocks started to walk in parallel when the financial crisis erupted, as all markets were jolted by the same broader economic conditions. Many investors had expected that to be a passing trend. Instead, the linkage has been in place ever since and recently grown even stronger. Last week, this high correlation was a double-whammy for investors who owned both oil and stocks. A 4% sell off in stocks was compounded by a 7% loss in oil prices." They go on, "The influence of stocks on oil became particularly evident in recent weeks as oil managed to rally despite its bearish fundamentals. Stockpiles of crude oil and petroleum products in the U.S. swelled to an all-time high in the week ending Aug. 6, while China, the primary engine of demand growth, cut back on its oil imports. Nevertheless, oil prices have gained 11% since late May." The Journal wonders if speculators are part of the cause, "Oil and stocks are joined up by actual money flows, as more fund managers start to trade in both markets. Many of them are so-called "algorithmic traders," who trade based on technical signals instead of fundamentals. Meanwhile, the growth of exchange-traded funds that are invested in stocks and commodities make it just a click away for investors to move assets around."

The Journal goes on to say, "Oil and stocks also cross paths in the so-called "risk trade." Traders generally think holding speculative investments, including stocks and oil, in a portfolio adds risk, and liquidating them removes risk. When their appetite for risk wanes, they pull money out of stocks and oil; when the risk trade is back on, they apply capital to both assets. The "risk trade" has reached a fever pitch recently, as traders grow jittery about the economic outlook." Now as I have said before, the reason for these phenomena is the Fed's policy of quantitative easing. The price of oil is being artificially supported under the guise that the policy will create economic growth and thereby energy demand and perhaps down the road, inflation. Of course that outlook is not as certain when the stock market gets weak as it did after last week's Fed meeting. For oil the main fundamental is the Fed and the success or failure of their policies.

Phil Flynn is senior energy analyst for PFGBest Research and a Fox Business Network contributor. He can be reached at (800) 935-6487 or at pflynn@pfgbest.com

About the Author
Phil Flynn

Senior energy analyst at The PRICE Futures Group and a Fox Business Network contributor. He is one of the world's leading market analysts, providing individual investors, professional traders, and institutions with up-to-the-minute investment and risk management insight into global petroleum, gasoline, and energy markets. His precise and timely forecasts have come to be in great demand by industry and media worldwide and his impressive career goes back almost three decades, gaining attention with his market calls and energetic personality as writer of The Energy Report. You can contact Phil by phone at (888) 264-5665 or by email at pflynn@pricegroup.com. Learn even more on our website at www.pricegroup.com.

 

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