Oil Reaches Center Stage Again
With all the action around the world, one big sector has taken a back seat for a while...but now oil is back in the spotlight after a suspicious down move after inventories grew, writes John Stephenson of Strategic Investor.
Global markets moved modestly higher last week after central banks rode to the rescue in September by easing monetary conditions.
The announcements from the European Central Bank (ECB), the Federal Reserve, and the Bank of Japan all helped move markets higher. Gains in Apple (AAPL), which started to sell its new iPhone 5, also helped boost the fortunes of US markets.
Risk assets were firmer, with copper leading the metals higher with a gain of 1.3% to $3.81 per pound, while the Australian dollar climbed slightly to $1.0438. There’s a whiff of excitement brewing for commodities and inflation-linked Treasuries, as investors start thinking about the possibility of inflation for the first time in years.
These expectations were given a further boost in the latest Federal Open Market Committee (FOMC) statement, in which the committee emphasized how long it will take to reverse course for both the zero-rate and on quantitative easing. Before stepping on the brake, the committee said they will need to see evidence of better growth and a big improvement in the labor market. And that’s got inflation watchers all abuzz.
But one commodity not taking the hint from the playbook for unconventional monetary policy was oil. Rather than rise, crude nosedived. The breakdown in oil futures left many experienced traders scratching their heads, as it ran counter to signs in other markets of a pick-up in expected inflation.
In theory, a torrent of cheap money should inflate the value of finite materials—but rather than rising prices, oil fell, reducing price pressures and giving central banks more room in which to maneuver.
The Fed announced QE3 on September 13 and crude rallied on the announcement. But by Monday, Brent crude tumbled $4 per barrel in just four minutes, and over the next two days it slid another $5.60 in what appeared to be a falling knife. Even with a partial bounce mid-week, the crude ended sharply lower.
Crude normally moves higher with QE, and a recent report by Bank of America Merrill Lynch projects that QE3 will drive crude 14% higher by the end of 2013 as money supply growth surpasses that of oil. But theory and practice are never the same. While the precise trigger for the sell-off was unclear, there are many theories to suggest crude’s plunge.
One rumor was that US authorities were planning a release of oil from the strategic petroleum reserves, while others reported that Saudi Arabia was acting to nudge prices back to $100 per barrel. Oil prices have tumbled to their lowest level in six weeks as Saudi Arabia, the world’s biggest crude exporter, has been offering extra oil to its customers for whom oil sanctions against Iran have depleted supplies.
Crude-oil prices have been pushed up over the past five weeks on concerns about rising geopolitical risk, amid increasingly hawkish statements from Israel, as well as the growing anti-US protests and unrest in the Middle East. However, with the prospects of an imminent attack on Iran by Israel fading, the Iran premium seems to have come out of the market.
Data released last week from the US Energy Information Administration showed that US crude stocks rose 8.5 million barrels last week, the biggest increase since March and a sure sign that supply is no longer a major issue. Yet despite the relative abundance of crude oil, gasoline prices rose to $3.878 per gallon last week, the highest level ever for this time of the year.
Also sapping enthusiasm for oil was the release last Thursday of weak manufacturing data from China . HSBC’s flash Chinese purchasing managers’ index, one of the earliest monthly economic indicators, showed that the figure was at a two-month high of 47.8, but well below the 50 mark, which points to contraction.
But despite the past week's plunge, the market for crude oil should be one of the first to rebound when global growth resumes. While it still may be too early to wade into the market for E&P companies, valuations for oil companies have become extremely attractive, suggesting a healthy bounce to the upside when oil prices move higher and stay there.