Oil dependent on economic growth and inflation

“Creativity comes from looking for the unexpected and stepping outside your own experience.”

Masuru Ibuka

The markets are back in a bit of a short term corrective mode as the US dollar is moving higher pushing oil prices and most other major commodity prices lower in mid-week trading. All of the major financial and commodity markets…including the oil complex continue to be primarily driven by the macro economic data and the perception of what the ongoing recovery will look like down the road. As previously discussed in the newsletter, the markets look at the developed world and see very slow growth at best and in some OECD countries, like Greece for example, still see negative growth. On the other hand they look at the developing world economies and see very robust growth but bordering on the fringes of inflation in many of the countries like China. In the developed world some countries are still providing economic stimulus like the US in the form of QE2 and a likely extension of the existing tax cuts while countries with robust growth are already raising interest rates in their effort to fight inflation… Sweden raised rates today as an example. China is likely to raise rates in the near future as its inflation gauge is well above the governments’ self imposed inflation threshold. In fact in a survey released today the Chinese consumer now views the risk of inflation at the highest level since the late 1990’s putting further pressure on the Chinese government to aggressively address the issue in the short to medium term.

So what does this all mean for the price of oil and other commodities going forward? The current view and resultant market sentiment for oil remains cloudy and uncertain and continues to be driven by mixed signals insofar as demand growth and the destocking pattern of global inventories. Oil inventories around the world have declined over the last several months but will the destocking continue as the developed world economies only recover very slowly and the emerging market world growth will slow down intentionally as governments fight the prospects of inflation? In spite of the plethora of forecasts calling for triple digit oil prices in 2011, I believe it is going to be difficult for oil to remain above the $100/bbl level for an extended period of time until it is clear that the majority of the economies around the world are actually growing at more normal rates than seen today or what may be expected after government tightening in certain countries like China for example.

Yesterday the US Fed FOMC met for the last time this year and ended the meeting as expected with a continuation of moving forward with its current quantitative easing program (QE2) of buying about $600 billion dollars worth of bonds and keeping short term interest rates near the zero level with for an extended period of time. This evolving strategy will continue to pressure the value of the US dollar versus most other currencies and should be medium term supportive for oil prices as well as the broader commodity complex going forward.

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