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.
I think capacity utilization is more important to watch right now. It looks to me like producers and consumers are in a war. Look at POT for example. They have cut a ton of supply in hopes of keeping prices up. However, the consumers, the farmers of the world, still aren’t buying because they cannot afford the expensive product. POT may not grow topline revenue for some time if they have to give price consessions in favor of higher volume. Higher volume will lead to a higher capacity utilization rate and possibly to higher profits, but not necessarily higher revenue.
This could be a multi-sector trend that would show up as poor retail sales numbers but with higher cap. utilization. Input costs could shrink (i.e. steel prices down >25%) and retail prices follow (lower car prices maybe?). This could help raise some producers profit margins but the lower sales prices would not show up as retail sales growth.
Also, such low cap. utilization sets the perfect stage for fierce competition. And competition leads to lower prices. The later years of the great depression saw a lot of “profitless prosperity”, where sales grew fast (from anemic levels), but profits did not.
Just my $.02
Jeremy
I’d be looking to see if companies decide that the green shoots are real enough for them to invest in new capacity (or at least to reopen shuttered capaciity.) No one is going to invest unless they think buyers are back. You watch the retail numbers and I’ll watch the cap spending numbers and between the two of us I think we’ll have it covered.
What will be lead indicators on economy ? How will we find out in advance that real economy is becoming better ? Maybe Retail Sales should give us a good idea as people who make real economy will actually start spending when they feel safe to do so mentaly and then real economy will move
So far all the good results of companies are due to cost cutting and reducing input prices because of downturn only and not due to topline growth so this good show will vanish in next 2 qtrs if real ie topline growth ie retail sales donot pick up very soon
So its quite possible that stock markets have gone much ahead of fundamentals of this moment and we have big leg down soon when truth catches up or DAWNS upon financial gurus .. So look for retail sales numbers for real growth if not coming then S&P 750 coming by oct.