Watch out: oil prices are climbing on hope and hedging

07/27/2009 10:02 am EST


Jim Jubak

Founder and Editor,

As investors go into a week of oil, oil, and more oil earnings news, it's a good time to ask the musical question (imagine I'm humming as I write this): Why are oil prices rising right now?

After hitting a low near $40 a barrel at the beginning of 2009, oil has climbed to about $70 a barrel recently.

Of course, it could be that with everybody and their Uncle Ben forecasting an end to the global recession in 2010, investors ae simply anticipating the increased demand that will come with the return of global economic growth. That's certainly a possibility. A Reuters poll of nine "top oil-tracking analysts and organizations," released Monday, projects that oil consumption will increase in 2010 for the first time in two years. The expected increase of 1.1% amounts to a pickup of 900,000 barrels a day to a global rate of 84.9 million barrels a day. That would still leave world demand short of the 86.2  million barrels a day it hit in 2007.

Perhaps. But I don't think so. I think we're at once of those wonderful moments where financial markets lead forecasters rather than the other way around. The rise in world oil prices in recent weeks--and the rise in forecastsof world oil demand--are built on financial trends that don't have much to do with demand and suppply in oil.

For example, it's no coincidence that the price of oil and other commodities has climbed as the dollar fell to near a seven-week low against the euro. Commodities, including oil, go up in price when the dollar falls because 1) many are priced in dollars so producers want more of a less valuable dollar for their commodities, and 2) as tangible things commodities are a good hedge against inflation and currency depreciation.

But I think the biggest "because" is climbing stock prices themselves. Because stock prices are going up, around the world, the global economy must have turned a corner and we are headed for economic growth sometime in the next six months. You can understand the attractions of this logic: We all know that the stock market anticipates the economy and so rising stock prices are a sign of better economic times ahead.

Unfortunately, there remains the very real possibility that the stock market may have it wrong and that rising stock prices aren't the signal of any news on the economy but of wishful thinking and over-extrapolation by investors. In this alternative explantion, oil analysts aren't raising their demand forecasts because of anything like real news, but because they read the financial news too and don't want to lag the stock market.

After all, we all know that financial markets never get prices wrong.

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