Wednesday, April 28, 2010

Phil Flynn: Oil On Junk


Oil prices and commodities got slammed on the S&P downgrades. They sent Greece to junk and Portugal is headed in that direction. Once again oil traders are reminded how much of the price of oil is dependent on some semblance of market stability. With the Fed dead ahead, oil traders have to realize that the price of oil transcends what some consider traditional supply and demand fundamentals. It is also a reflection of how the world views the economy and the relative value of the currency backing this commodity.

In the beginning of the financial crisis oil soared towards $147 a barrel and I attempted to explain that things were amiss. The price move in oil was out of line with the five year average price increase that already reflected stunning oil demand growth. I was scoffed at by some when I suggested that the spike in oil might lead to demand destruction. That the world economy had not “decoupled” from the US economy and that no matter what, Europe and China would consume oil even if the US banks started to fail. The naysayer and the blindly bullish say that the price move was just a function of peak oil and the prices would continue to soar higher and that price would have little impact on demand.

Yet I said that oil was being used as a safe haven and a hedge against systemic risk as the sub-prime crisis began to evolve. Of course the skeptics say it was nothing but a case of speculation gone wild. We remember that we were told not to worry because sub-prime crisis was less than 10% of all mortgages, the same way some are saying now not to worry about Greece because it is such a small economy.

We may see oil come back a bit today. The Greece crisis is in the market for the time being and oil may focus less on the loss of demand created by this crisis but by the fact that this crisis may ensure that US interest rates will stay lower for longer than expected. The Fed Fund Futures November contract which had priced in a 74% chance of a quarter point interest rate increase fell 15% after the European downgrade after the news. If the oil market gets the sense that interest rates are going to stay low for a longer and longer period of time, then oil becomes more bullish. It becomes bullish because the dollar will get weaker and it will get stronger as oil already puffed up on cheap printed oil stimulus money, then we can continue to see this global demand growth until the bubble eventually pops.

The Fed meeting will be key! The best way to get that news is watching it on the Fox Business Network where you can see Phil every day! Phil can also be reached at pflynn@pfgbest.com.


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