Most of us won’t have noticed much market mayhem going on in our daily lives, distracted by terrorism in the heart of Europe. An instantaneous jump of 30% in the value of the Swiss Franc last week means very little to most people. If only we had stashed a few Swiss Francs in advance.
Most readers of this piece should be aware that the price of oil has more than halved in the last 6 months rendering much of the global oil industry unprofitable which is an unprecedented disaster for all of those dependent upon oil in their daily lives. But what is the underlying cause of all this market mayhem and does it really matter? The S&P 500 is, after all, riding high and the US Dollar keeps marching towards new highs against the Euro and other currencies. This post takes a look at a number of indicators searching for answers which are elusive.
Figure 1 The copper price has been on the skids since 2011, recently breaking through the $3 support. This is a sign of chronic weakness in the global economy, probably linked to China (Figure 2). Chart from the FT.
Figure 2 While China still has GDP growth over 7%, an enviable value, GDP growth rate has been slowing and has halved since 2007. The rate of growth for raw materials and imported luxury goods is presumably slowing and I dare say is part of the story behind weak copper and weakening Euro zone economies. When the World’s second largest economy catches a cold, it’s possible the rest of the world gets influenza. 2014 is estimated.
Figure 3 The economic performance of these four Mediterranean countries since the 2008 crash is, in short, shocking. Largely down to strain of being in the Euro zone. The 2014 data are not yet in, but currency and political woes seem to be continuing unabated, especially in Greece.
Figure 4 The economic malaise of the Euro zone is reflected by the Dollar/Euro exchange with the Euro setting record lows in recent weeks. This chart has much in common with the copper price (Figure 1). Chart from the FT.
I’m sure many other countries are suffering from similar economic malaise that seems to have no end. These OECD nations are already joined by Russia and will shortly be joined by the majority of OPEC countries.
I want to move on now to the oil price (Figure 5) and in particular the WTI – Brent Spread (Figure 6).
Figure 5 The oil price crash is not unprecedented. In 2008 – 2009 it was associated with the biggest recession the world has known since 1929.
Figure 6 The chart shows the daily price for WTI less the price for Brent. WTI traditionally traded at a small premium to Brent. At around the year 2000 the small positive premium got a bit bigger and more volatile and then during the latter stages of the great oil Bull Run it became very volatile and turned negative. Post 2008 crash the wild oscillations continued until January 2011 when the spread turned sharply negative reaching $30 at one point. But now, as quickly as the yawning gap opened it has closed again. I’d quite like to know why the markets sustained such a large spread in the first place and why it has just closed.
One version of events is a glut of oil in Cushing Oklahoma caused in part by rising Canadian oil sands production and LTO production in the USA combined with a pipeline being run in reverse direction. Depressed prices in the mid-West was good news for refiners. For some reason, I’ve never fully bought into this story line.
An alternative or complimentary theory has been ventured by Chris Cook and that is Saudi Arabia has utilized QE dollars to manipulate the price of Brent. I’m not sure I buy into that story either but would not discount the possibility that the WTI-Brent spread is the result of market manipulation. There certainly seems to be a correspondence between the end of QE in the USA and the subsequent crash in the oil price (Figure 7).
Figure 7 The chart is from Chris Cook (former compliance and market supervision director of the International Petroleum Exchange). Chris Cook says this: “This simple chart shows how the US Fed Quantitative Easing (QE) and Twist programs of dollar creation are almost perfectly correlated to the US WTI crude oil benchmark price: itself linked to the Brent/BFOE benchmark oil price.”
I’m afraid I disagree with the detail of this commentary but can agree with the general point. QE-1 probably saved the banks in 2009 and the world economy with it. But has the ending of QE3 undone all the balance sheet repair work of the past 6 years? I think we need to consider the possibility that the coincidence of the oil price crash and ending of QE3 is just that, a coincidence. Unless of course the Saudis really were manipulating the market.
Chris Cook had an Oil Drum post in January 2012 that is still worth reading:
From 1995 to 2007 BP and Goldman Sachs were joined at the head, having the same chairman – the Irish former head of the World Trade Organisation, Peter Sutherland. From 1999 until he fell from grace in 2007 through revelations about his private life, BP’s CEO Lord Browne was also on the Goldman Sachs board.
And more recently on European Tribune:
Fed Chairman Janet Yellen
Finally, not a chart but a picture of someone who we must hope is incredibly smart and who appears to not lack courage. Janet Yellen, chairman of The Fed, is responsible for ending QE and signaling the end of government intervention in markets. My friend Ilargi at The Automatic Earth had this to say:
What we see now is the recovery of price discovery, and therefore the functioning economy, and it shouldn’t be a big surprise that it doesn’t come in a smooth transition. Six years is a long time. Moreover, it was never just QE that distorted the markets, there was – and is – the ultra-low interest rate policy developed nations’ central banks adhere to like it was the gospel, and there’s always been the narrative of economic recovery just around the corner that the politico/media system incessantly drowned the world in.
That the QE madness ended with the decapitation of the price of oil seems only fitting. Our economies need oil the way people – and animals – need water. If its price falls the way it has, that’s a sure sign something is profoundly amiss. At this point, we don’t yet know the half of it. It’ll take time for price discovery to work its way through, and for people to recognize what things are really worth. For now there’s really only one that’s certain: everything is overvalued, including you.
And so to try and conclude. This from Oil Production Vital Statistics – January 2015:
The plunge continues at a similar speed to the 2008 crash. The 2008 oil price crash began in early July. It was not until 16th September, about 10 weeks later, that the markets crashed.
Few if any of the core issues that lay at the heart of economic woes in 2008 have been fixed. Too high borrowing continues, too high debts, zero interest rates, the spectre of deflation, bankers bonuses, low pay growth for the masses, OECD unemployment, corruption, the unstable Euro zone, recession in many OECD countries and now slowing growth in China. It is difficult to pick a date for the beginning of market mayhem but the end of October, when The Fed ended QE3 is as good a date as any. 10 weeks is already up.
If the world discovers that $50 is the right price for oil it is also going to discover that several million barrels per day production will be wiped out and that the world economy will have to shrink to accommodate the narrower energy base. This may be strongly deflationary. It will also cause extreme distress in Russia, Iran, Iraq, Algeria, Nigeria and Venezuela. However, I will stand by my earlier analysis of Oil Price Scenarios for 2015 and 2016 and anticipate that the oil price recovers strongly next year. Companies and countries will have to hang tough this year.
By Euan Mearns
Source - http://euanmearns.com/
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