Rising inflation around the globe is putting heat on the oil bulls. The Wall Street Journal has two stories on their front page about inflation and its impact on commodities and the implications for prices when extraordinary stimulus is removed. The price of oil, as any reader of The Energy Report knows, is a product of historic global economic stimulus.
QE1 and QE2 and a QE to be named later, have been the backbone of the market as the Fed tried to battle deflation. The Fed instead decided to create inflation by flooding the markets with freshly printed dollars. Ok, maybe the Fed doesn't want to portray it that way, but the truth is that this flood of cash has set the stage for the situation that we have today. The Fed exported deflation to the emerging markets and now the situation is forcing the market to look ahead to a world where global central banks will be a little less accommodating.
Take Wall Street Journal story Number 1: "Inflation fears-fueled by spiraling food, oil and raw material prices-are mounting around the globe, prompting the head of the European Central Bank to signal that it could raise interest rates in the future even though some countries have been weakened by the continent's debt crisis…In an interview with The Wall Street Journal ahead of this week's annual meeting of the World Economic Forum in Davos, Switzerland, Jean-Claude Trichet warned that inflation pressures in the eurozone must be watched closely, and urged central bankers everywhere to ensure that higher energy and food prices don't gain a foothold in the global economy. Mr. Trichet's warning comes at a time when inflation concerns are mounting among investors around the world. Fast-growing emerging markets such as China and Brazil are seeing rising inflation at home, and their demand for globally traded commodities is pushing prices higher elsewhere. While high unemployment and spare capacity are restraining underlying inflation pressures in the U.S. and elsewhere in the developed world, annual inflation in China is almost 5%-and a sizzling 9.8% economic growth rate in the fourth quarter triggered fears of more price pressures ahead. Inflation in Brazil is even higher."
Wall Street Journal story Number 2 reports that the markets "Relearn Fundamentals." The WSJ said, "Greed and fear no longer seem to be playing such a violent game of tug-of-war with markets. After a long stretch in which macroeconomic hopes and fears dictated the rise and fall of stocks, bonds and commodities-known in the market as the risk-on, risk-off trade-there are tentative signs that more traditional concerns are reasserting their power. In recent weeks, moves in stocks and the U.S. dollar have had little connection, a breakdown of the trend during much of 2010, when they were virtual mirror images of each other. Stocks were considered risky and would rise when investors were feeling confident, while the dollar was a haven, benefiting when investors were worried. Commodities, too, have broken away from rising and falling with risk perceptions. Now more old-fashioned concerns, like the weather, are having an impact. Corn, soybean and wheat prices jumped this month after supply estimates were cut because of dry weather in South America and floods in Australia. That could be a relief to investors frustrated by what they see as a market often detached from fundamental concerns, thwarting efforts to make long-term trades."
Yet the truth is that commodities were always following the fundamentals, just not the traditional fundamentals that everyone thinks about. Commodities were following the most basic fundamental which is the value of the underlying currency that is exchanged for the desired commodity. That comes down to confidence. How confident is the seller of a valuable commodity going to have in a piece of paper that is trying to be exchanged for said commodity? The risk trade was basically a confidence trade as the market tried to judge the risks in a global economy that was coming apart and tried to get a sense of what country may be on the verge of default.
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 firstname.lastname@example.org.