Notes From Underground: HIGHER OIL … Greasing the Skid or Lubricating Liquidity

Sorry, couldn’t resist the obvious. Many MOONS ago if OIL PRICES were rising the BOND MARKET WOULD BE GETTING SOLD, EQUITY MARKETS WOULD BE STRUGGLING AS IT WAS FEARED THAT THE FED AND OTHER CENTRAL BANKS WOULD BE RAISING RATES TO STEM THE FEAR OF INFLATION. WHAT A DIFFERENT WORLD IN WHICH WE INVEST. As oil prices head higher, the bonds and equities both rally as did the PRECIOUS METALS.  SO WHAT DYNAMIC MAY BE AT WORK?

Stock market bulls are buying stocks based on higher oil on the theory that global demand is driving OIL higher as an indication that ECONOMIC GROWTH is improving  everywhere but Europe. However, the BRENT CONTRACT is outpacing the WTI, which throws the EUROPE story out, therefore the OIL must be rising because of geopolitical concerns. Can’t have it all ways so what we are left with is HIGHER OIL PRICES!

So how can it be that higher oil prices caused by geopolitical fears have not created a SELLOFF in the EQUITY markets and other assets? If OIL were to be a drag on growth shouldn’t the fragile global growth story be the death of the recent STOCK MARKET RALLY? If we weren’t living in a BALANCE SHEET RECESSION WORLD we would probably be seeing the FED nervously reacting to increased OIL prices. But in a deleveraging global economy it seems that any threat to global growth just gives the FED, ECB and BOJ an excuse to keep the liquidity spigot open.

It seems that fear of higher OIL is deemed to be a threat to growth and therefore the ZERO INTEREST POLICY IS TO BE MAINTAINED AND ENHANCED. As long as the DEMON OF ASSET DEFLATION AND ADVERSE FEEDBACK LOOPS ARE CONTAINED THE GLOBAL MARKETS ARE CONTENT, A GUSHER OF LIQUIDITY IS THE DOMINANT VARIABLE FOR THE MOMENT.

On February 29 we will listen to see if ECB President Draghi mentions the threat of very high BRENT CRUDE prices as a reason to err on the side of extra liquidity by increasing the SECOND TRANCHE to the highest expected levels. If he mentions the high oil prices all asset classes will breathe a sigh of relief and continue the rally.

This is truly a different world then many years ago when higher prices sent a TOTALLY DIFFERENT MESSAGE TO THE MARKETS AND INVESTORS. Higher oil prices beget higher equity prices and higher BOND PRICES. Why the world of investing must be seen through the LENSES OF DYNAMIC ANALYSIS. NOTHING IS EVER THE SAME; NOR ARE ALL THINGS BEING EQUAL.

***The focus will be on the impact of HIGHER FUEL PRICES BEING A DRAG ON THE CONSUMER. MAYBE THERE IS A REASON FOR FED POLICY BESIDES EUROPE“I TELL YOU JANE IT’S ALWAYS SOMETHING.”

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8 Responses to “Notes From Underground: HIGHER OIL … Greasing the Skid or Lubricating Liquidity”

  1. huh? Says:

    Everything I read says currencies are devaluing (imagine that) so it takes more to buy a barrel of oil whereas gold is climbing alongside oil so that ratio (gold price to oil price) is staying about the same so no absolute panic in pricing there…yet. Just that oil is worth more than paper lately. If this spike continues, it foretells Iran being thrown into the mix.

    All that electronic credit could morph into being real paper money, flooding the system(s) causing what they say is ‘cost push price inflation’ as there is no definitive definition of inflation/deflation it is sometimes hard to follow the bouncing ball.

    In these conditions, hard to believe outstanding debt just doesn’t suck up all the excess money. Must distribute money out of a fire hose to make stock markets rise, at the same time gaining nothing. Makes for good press but the working class sees it differently esp. at the gas pump.

  2. yra Says:

    HUH–ALL POWER TO THE RENTIER CLASS AND THOSE WHO PARTAKE OF THE PORTFOLIO BALANCE CHANNEL

  3. kevinwaspi Says:

    Yra,
    Couldn’t agree more. IF the central banks of the world stop treating the current deleveraging process like a liquidity problem and start treating it like a balance sheet problem, we could possibly see a more “rational” marketplace. As long as central banks ARE the markets, we can expect to see the vast majority of the population squeezed between bad politics on one hand and bad economics on the other hand. Take the portfolio balance channel to the political extreem, and we should all be buying the stock and bonds of “green energy” companies. Long Live the Government Hedge Fund!
    I quote; “The way to crush the bourgeoisie is to grind them between the millstones of taxation and inflation.” (Vladimir Lenin)

  4. Kevin Says:

    We watch the correlation between the oil price and the Sensex (Indian) market in USD – currently strongly positive – risk assets all enjoying the easy money together. However when the first wiff of inflation fear comes to emerging markets, it seems to show up first in India.

    With the bulk of their oil imported, and a subsidised retail price for fuel, higher oil = higher current account deficit AND higher budget deficit. Given that in 2011 these were -3.5% and -5.4% respectively, they are a good “canary” for inflation fears, because these metrics can quickly deteriorate. The correlation went very negative in early 2008 (while markets were still going up) and then again in Q1 2011.

    Not to worry now though – Sensex nicely +vely correlated with oil. The canary is relaxed and singing sweetly!

  5. yra Says:

    Kevin–very good post and thanks for the insight.

  6. MattW Says:

    Truly a different world indeed. Although personally I’d be surprised at a reference by Draghi to high oil prices unless it is to pay lip service to the Buba contingency. With taxes/duties making up for almost 2/3 of European final fuel pricing, I’m not sure the recent rally in oil has hit the collective consumer behavior yet, probably not in Europe and I’d venture to say definitely not yet in countries with relatively strong currencies that are not yet looking at record oil prices – US, China, Japan unlike EZ and UK). Actually an interesting piece on this last year by James Hamilton where he notes not only the high correlation of oil prices to post war recessions but, most importantly, the fact that spikes above ‘recent’ highs (i.e. rolling 12 month) are much more impactful to consumer behavior/growth than absolute price levels. http://dss.ucsd.edu/~jhamilto/oil_history.pdf
    All that said if we look at the already weak EZ economy and now potentially weak demand in Asian refined products (Singapore gas oil swaps dropping into contango), the demand side looks weaker than last year whereas the supply side looks similar (production down in S. Sudan, Yemen, Syria).
    There’s some talk now but the logic behind IEA stock release last year exists now and it seems action there would have a greater effect on the price than last year’s release. I’d assume they’d wait until we get through spring maintenance and gauge US summer demand, but from a trading view what better time to hit the market with a stock release than when the demand side may be looking softer (similar to their move last year in ‘selling’ into a falling market).
    The big negative skew in oil vol surface is starting to flatten, and I’d like to watch this as a true sign of bullish exuberance and if the negative skew does fully dissapear then maybe that’ll be the time to look at shorts (at least short term). Managed $ long/shorts ratios are already looking a bit stretched although there’s still upside to previous highs of outright long positioning.
    Interesting regarding the reference by Kevin to Sensex vs. oil as a leading indicator of EM inflation.

  7. MattW Says:

    edit after today’s report: long-short ratio for mgd money looking MUCH more stretched now, only been higher twice (absolute and net longs still below other highs)

  8. yra Says:

    Mattw–Great post –very informative.Again,I am impressed by the readers of this blog as the knowledge base is very deep and the shrill voices have gone elsewhere to seek a platform and this has kept discourse to a very high level.

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