Do Oil Markets Signal A Global Downturn?

I take the demand for dollars and safe sovereign debt as a warning.

By Martin Tiller, Oil & Energy Insider:

Over the last few months, market watchers have become accustomed to a situation, or rather a correlation, that makes no sense. Oil and stocks have tended to move in unison. From a basic, fundamental perspective that is patently absurd. Energy costs are an important factor in the overall profitability of businesses and have a big influence on consumer behavior too, so higher oil should be a warning sign, not an indication that everything in the garden is rosy.

This week, though, we have seen signs that the correlation is now fully broken. Stocks have recovered rapidly from the Brexit news, while oil has stayed lower. The question, of course, is which is right?

The recent correlation has come about for two basic reasons. Firstly, from these levels even higher oil is still, as compared to the recent days of $100+ WTI, low and therefore nothing to worry about. Secondly the potential negative effects of higher oil have been less important to stock traders than the implications of oil’s movements for global growth.

Both of those things still apply to some extent, but the further we move away from $100 oil the less relevant it becomes.

That leaves us with implications for global growth. And in that respect, I would say that it is the stock market, not oil, that is out of whack. There is plenty of evidence to support that theory. First and foremost is what other markets are telling us. I probably have a bias due to being trained in a forex dealing room, but I was always taught that the most reliable indicators of overall economic conditions and prospects are, in descending order: forex, bonds, commodities and then stocks.

Those are the markets that count, and the U.S. stock market is alone among them in bouncing straight back from the Brexit shock. The dollar remains elevated and, sovereign debt, from the U.S. and other developed nations, is at record levels. That is not specific to one part of the curve either; both the 10 and 30 Year Treasuries have touched record low yields.

Call me old fashioned, but no matter what central banks are doing, when I see huge demand for dollars and safe sovereign debt, I take that as a warning.

The stock market, it seems, is concentrating on the prospect of more free money from the Fed and seems to have convinced itself that Brexit either will not happen or will have a very limited effect. The likelihood that the Fed will at least delay increases, however, comes from their perception that there are real problems in the global and domestic economies, so to my mind is hardly encouraging.

I guess there is a possibility that Brexit will not happen, but, given the promises made that looks unlikely, and if it does the effects will be noticeable. If nothing else, as the story develops in the U.K. the related news will cause volatility in the short term.

Given the choice, I will nearly always take the forex, bond and commodity markets over stocks. They are more indicative of the global mood and less subject to irrational moves based on perception and momentum.

There are some serious challenges to the global economy on the horizon. Not only do we have Brexit, but also a worrying political trend towards protectionism and, although most seem to have forgotten all about it, China is still in the process of transition from manufacturing to a more advanced economy. All of those things outweigh the stock traders’ delight at more free money, and the oil market’s caution looks far more realistic than the stock market’s optimism. By Martin Tiller, Oil & Energy Insider

Is the honeymoon of junk bonds already over? Bad breath of reality next? Read…  What the Heck is Happening to Junk Bonds?

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  25 comments for “Do Oil Markets Signal A Global Downturn?

  1. William says:

    Nice article. A US recession has been delayed and a frothy stock market stays elevated. I follow the gold/oil price ratio and saw the deep dive in oil prices as temporary since the price of gold didn’t follow. I still suspect oil will rise, then rise more, then at one point be blamed for tipping the US into a recession.

  2. Petunia says:

    The trend in energy prices is down and it is consumer driven. We recently moved and our millennial son convinced us to buy LED bulbs for the house. We always take the energy efficiency of everything we buy into consideration. The bulbs were expensive but we can already see the savings in the monthly bill.

    I watch international tv and the trend in even the remotest places is to use solar where ever possible. The latest show I watched featured a house in the middle of nowhere in Argentina, running on solar. It is common to see windmills on American farms. The grid is becoming obsolete, alternative energy is becoming normal, and all this drives demand down.

  3. nick kelly says:

    The most shocking number I’ve seen is courtesy of WR: Manhattan condo prices down 14% in 3 months.
    That is not a correction that is a crash. I don’t have a calc handy but if that rate was to continue (unlikely) for a year you will have lost at least 75%.
    But lets say it’s only 30%

    • Nicko says:

      Rents are still rising in Manhattan, until you get a crash in demand, there will be no crash in sales.

    • EVENT HORIZON says:

      Why do people think “14%”down, from inflated BS prices to begin with” is a “crash”?

      When a car dealer offers 10% off List, do we scream crash?
      When a restaurant offers 2 for 1, do we scream crash?

      14% “off” is nothing.

  4. nick kelly says:

    RE: China’s transition to a consumer economy.
    It fascinates me the way the media has bought into the CCP line that this was a deliberate act.
    It’s like the CCP said: let’s shut down cement, steel, coal, aluminum, ship building etc. etc.
    No- the former were mostly bankrupt.

    The CCP party line so eagerly gobbled up by pundits ( along with the 6.9 growth number) is an example of making a virtue out of a necessity.

    It resembles Putin’s reaction to western sanctions- ‘oh good now we can learn how to make ( fill in blank)

    The industrial economy evolves into a consumer economy- it isn’t accomplished by a wave of a party wand- especially when that party is the CCP.

    • illumined says:

      From what I’ve read the CCP is doing the opposite by reinstating direct party control over their SOE’s, essentially reversing a couple decades of SOE reform. No doubt this will exacerbate the problem.

      I think the media as a whole is vastly underestimating just how enormous China’s bubble really is and wildly overestimating how much control the CCP has over it. Early this year the PBoC dumped $1 trillion worth of credit into the economy, all that stimulus has already worn off.

    • MC says:

      That willingness and readiness to buy into Beijing’s press release may seem bizarre until one recalls our media had exactly the same relationship with the good old USSR. Nobody questioned the numbers for cement and steel production, let alone if those numbers were merely produced for consumption by gullible Westerners and contrasted starkly with the reality people saw on the ground (long story short: the Iron Curtain was anything but impenetrable, especially when the Soviets needed something really badly).

      I’ve long suspected this is due to the fascination central planning has long had for the well eductaed, especially those in the West who have no direct experience of it. The idea of parcelling out growth, picking winners and losers and to have a whole society develop according to a paper model is simply far too strong for many people.
      That’s why they bought into the idea China has somehow found the recipe for a perfect working command economy while in reality that phenomenal growth was simply the result of a series of lucky coincidences which are now running out.

      • Tim says:

        The Krupps were selling into the USSR. The Krupps were giving such a good deal, that it contributed to Krupps problems in the mid – late sixties.

    • EVENT HORIZON says:

      The Chinese are almost funny. It is a 1 Billion + Cargo Cult economy. All they do is “copy” the West, from the absurdity of Karl Marx, to mini-Manhattan. Sad, but, in a way, funny as hell. “Round Eye” builds huge buildings, so we build huge buildings. “Round Eye” builds air=ports, so we build airports. Funny as hell.

      The real tragedy is that the ant-hill of China is wrecking the rest of the world. The “China Price” for products distorts the real cost of just about every product. Since the economy is Communist Capitalism, versus Free Enterprise Capitalism, nobody knows the real cost of items anymore.

      If China was a dinky little country, then it would not have global significance, BUT, since they manufacture so much, they distort the true costs of a product. This will not end well.

      China distorts the prices of raw products, labor and the finished products. They cause raw-material providers like Australia and Canada to distort their own productions, give false value to their resources and labor.

      Then, since their people are SLAVES, they distort the cost of labor. Put thousands of women into rabbit hutches next to the factory floor, make them work ungodly hours, run a duplicate line of products (especially names like GUCCI, FENDI, etc which is un-accounted for and goes out the back door to the black market) and then

      Sell the products world-wide at a fake exchange rate, undercut everybody regardless of any real profit or loss (since nobody knows that the true cost of production is)…

      And then call this an economy. “Round Eye” make steel. We make MORE steel, so we richer !!!

      When this blows up, and it has to, some day, it will be magnificent to behold.

  5. Rich people buy shares. They also buy gold, collectibles, currency futures, Picassos, mansions, yachts and private jets. Occasionally they buy lottery tickets. The rich get richer …

    Poorish people pretend to be rich and buy cars. They cannot afford mansions of jets. When they’ve signed up for the mega subprime car loan and add it to ordinary expenses they have less in-pocket for gas. In places like (not so) Merry ol’ England (China) their currency is depreciated by ‘market forces’: 11% depreciation means every English is poorer by that much relative to the dollar world. That means less dinero to pay for gasoline, diminished bid for fuel on wholesale markets. Call it ‘trickle up’ un-economics or ‘disutility’ as John Maynard Keynes might put it.

    Add non-stop QE … in Japan, EU, and US … and credit is shifted away from the customers toward the same finance freaks bidding up the price of crude oil futures. Less money => the customers cannot pay the refiners => they don’t buy wellhead crude unless they are willing to take a loss. If refiners don’t bid, the crude winds up in storage.

    Bloomberg sock puppets will say there is a glut but in actuality there is excess inventory build on top of a longer term shortage. The customers are going broke faster than the oil supply is shrinking, it looks like a glut. There was a real glut in 1998: Saudi Arabia had 5 million barrels per day excess capacity shut it … instead of a few hundred thousand puny barrels.

    You. Ain’t. Seen. Nothing. Yet.

    There is no organic support for oil prices. Only 5- or 6% of total fuel use is remunerative the rest is waste supported by (colossal) credit flows. Now credit is dying. UK didn’t punt the EU because they were so brilliantly successful. They did so b/c both the UK and EU are bankrupt. They have gotten this way b/c of the exorbitant fuel + credit bills than none of the above can afford.

    The price that can be supported by actual use is probably $5 per barrel. You can guess how much of an oil industry the world will have at that price. Tighten you chin strap we are all going to find out.

    • William Muscato says:

      Rich people sell shares more than buy them. Consider the business owner that takes company public and sells share for money he will never have to pay back, and he can consider creating shares then sell those new shares too. Also for company executives and board of directors, creating shares to give themselves for selling. I’ve seen CEOs sell billions of dollars of shares and when they finish a decade of selling, the remaining company has a value much lower than all the money the CEO pulled out himself.

    • Paulo says:

      Well said, Steve.

      In very simple anecdotal terms it used to be that a working guy where I live had a pretty nice lifestyle. Although vehicles weren’t as fancy, no ‘smart’ phones, stereos pretty rudimentary, little consumer fluff, etc., at least a wage earner could afford a new car or truck every few years, a house, beer night out, smokes, and maybe a roast dinner on Sunday nights.

      A barrel of oil back then was close to 1 to 1.5 hours of wages . Today….$50.00 oil is thought to be on the cheap side. Most working guys do not make $50.00/hour. When it inevitably rises to $100+, everything will be waaay out of reach as oil is in all facets of our lives. Add to this $5.00 for a mug of beer, $20 parking, $100+ for a carton of smokes, $4-5,000 year property taxes….user fees for everything, and health care costs in many countries beyond belief, this is a house of toppling cards. People will simply have to scale back big time in order to tread water.

      That is the picture of decline, one unaffordable thing after another. The last thing to go for many will be the credit card and the LOC.

  6. Sgt Milstar says:

    Banks have been reducing their excess reserves of deposit with the FED. The pattern follows the crash in oil prices. My question, have the banks been speculating in oil futures with the goal of raising the selling price of oil?

    Banks have an vested interest in the oil patch.


    • marty says:

      That’s what I thought when this move up got so steep. The banks have been manipulating many commodities over the past, what 10 years? Remember the warehouses full of aluminum? I can’t believe they’d leave oil alone. Rumor has it that when oil storage was getting dangerously short in the US, they move to China which averted another plunge this spring.

  7. Agnes says:

    I have never read the original study, but it makes sense to me that we don’t like to commute more than an hour to work.

    This impacts the size of cities.

    What will we do without cheap oil? (I am buying a more expensive chinstrap, and maybe one of those flying suits like Lara Croft used, because I truly fear low prices when the next step is…shortage).

  8. night-train says:

    Some say yes. Some say no. With everything so hyped and manipulated, it is difficult to make sense of the markets, much less finding supportable market prices. When OPEC controlled the market they provided stability more often than not. Now it appears to be the wild west, although I question many of the numbers we are given. I fear we might be just as well off trying to divine omens from badger spleens.

    The author’s point about oil indicating the market trend may well be right. But, from what I can tell, we are expected to make decisions using the least flawed stats. And I am afraid that may be like panning for gold in a mined out stream. It takes a whole lot of work for very little yield.

  9. Spencer says:

    …”when I see huge demand for dollars and safe sovereign debt”…

    Like drunken bums laying in the gutter, all the sovereigns no less! And we should lay with them? No thank you, I, prefer my to be my own central bank.

  10. Meme Imfurst says:

    Any notion that there is an oil ‘resource’ shortage is non sense, just look at the facts, look at the data, look at what Russia has alone, look at cargo storage off shore. Oil volume to the market, just like diamonds, is controlled to keep the price form collapse. Of course the central banks have a hand in propping up the latest attempt by the market to ‘self-correct’ . The use of options was to keep any commodity moderated, but is now used to crush or enrich speculators just as they are used in the stock market now. Out of control, everything is manipulated in microseconds.

    On the street, those gas prices matter to the survival of the general public. I live in a Tourist town and as soon as gas hit 2.20 the numbers died off fast. It is 2.61 right now and the town should be packed, it isn’t.

    • Paulo says:

      Conventional Oil, (Jed Clampett oil pumped from the ground) peaked in 2005. All the weird stuff added in; bio-fuels, condensates, gasahol, LTO, + very deep water supplies peaked in 2015.

      The price of gas is currently low because there is approx. 1.5% excess supply due to cheap debt promoting surplus supply to consumption rates. Corn is cheap in late July, too. The economy is in the toilet, and that is a major reason why the price is low.

      When supplies decrease, watch out. The noise you will hear will be cries of: “I thought we were energy independent.” Whatever happened to Saudi America”? And my personal favourite, “Nobody told us this would happen”.

      Right now, oil is being burned at 10X the rate of new discoveries. There are very few countries left in the world that are not past their peak oil production levels, and they are not the big players. US is not on that list, and neither is Russia or Saudi Arabia. Think Canada, and Canada produces just over 4 million barrels per day, with only half of that surplus to her domestic needs.

      Hang on.

  11. Uncle Frank says:

    Oil price increase hasn’t stopped continued rise in unemployment

    WICHITA FALLS — Even though crude oil prices increased for the third consecutive month in May, unemployment continues to rise as 100,000 upstream jobs have been lost, according to this month’s Texas Petro Index (TPI).

    • night-train says:

      Uncle Frank: I believe that $50/bbl. is a price that the conventional producers like the Saudis can make a reasonable ROI, while still being too low for most of the US shale producers to be profitable. Early on in the bust, the experts said that the US O&G producers wouldn’t lay off professional technical staff such as engineers and geologists. During the early 1980s bust, companies shed these jobs to the extent that very few of these employees were educated and trained for about a 15 year period. When things took off in the mid 2000s, the O&G companies found it difficult to acquire these professions.

      But then, the US O&G industries, especially the shale players, did lay off many of these workers. So, how do we interpret this development? Is it a capitulation, in which these producers are demonstrating with actions that they expect oil prices to remain below shale oil profitability long term? Many of these workers are still living where they were, using up severance pay and soon, savings and credit cards. So, if the price rebounds over the next 6 months, they will gladly return to work. But the longer the price stays down, these people will drift away and be less likely to return.

      So, how do we read these tea leaves? Do they know this is a long period of low oil prices ($50 or less)? Or, are these companies just cutting costs, expecting these formerly highly paid employees to still be on the market when prices rebound in 2017-2018?

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