I believe that sometimes the market as a whole can be smarter than each of us individually.
Maybe this is one of those times.
The price of a barrel of crude oil has come down from near US$77 per barrel to US$61- something in what seems like a correction that has yet to find its end. Three days out of the past two weeks the spot oil price did not fall. Three days.
It won't be long before we will see the market flooded with reports that technical charts have now turned bearish. From a pure, straightforward, logical perspective this means that oil seems to have only one way left to go and that is further down.
What is happening on the global share markets? They are going down as well.
Correct me if I am wrong, but I thought cheaper oil was what we all wanted to see. Unexpectedly high inflation was either eating into company profits or forcing central bankers to keep a tightening bias (because it was also pushing inflation higher). Not good, especially with US consumers battling a nasty housing downturn.
Their peers in Australia seemed once again lucky, enjoying a large tax cut recently so most economists would argue they had been more or less compensated for two rate hikes so far in 2006. It was expensive petrol at the pump that kept testing consumers' mettle.
This is a time when negative news becomes positive, I wrote a few months ago, as long as it doesn't turn out to be too negative. I am certain lower oil prices would have been welcomed with higher share prices at the time.
So what has changed?
The world has turned more cautious over the past few weeks. When we first picked up professor Nouriel Roubini's doom scenario of a pending recession in the US, most economic commentators were firmly in the it'll be alright zone. Hardly any of them would seriously contemplate the R-scenario in July.
We again published a story today centred around Nouriel Roubini's doom and gloom outlook for the US economy (and thus for the global economy and share markets). Only this time around the surrounding context is drastically different.
More and more economists are mentioning the danger of a genuinely hard landing for the US economy, even though most are also still positive about the chances such a scenario can be avoided. The US bond markets have started to price in Fed rate cuts throughout 2007 though. With sharply lower oil prices this scenario looks less likely by the day, given lower oil prices may be sufficient alone to restimulate the economy. So are we in for a prolonged period of volatility because of market sentiment swings between expectations of further rate hikes and interest rate cuts? It would seem this has now become inevitable.
There's a second scenario that is unfolding as all this is going on inside the offices of global fund managers and equity strategists: together with the spot price of oil, most other commodities are being pulled lower as well.
Now that doesn't seem to make sense either, because cheaper oil should make life easier for resources companies and their customers. Cheaper oil should stimulate the economy and thus demand for natural resources.
So what is the market telling us?
Maybe Roubini is right and the US housing market will come down as Icarus falling from the sky, dragging everything else with it, including the demand for commodities. Under such a scenario it doesn't really matter whether oil costs a few cents more or less at the pump – it will by definition cost less over time. If US consumers stop spending the world will (be forced to) take notice and US interest rates will go down regardless whether short term gloom and doom can be avoided or not.
Maybe Roubini is wrong, but he will still get it his way as US consumers and businesses will grab the opportunity of a lower oil cost to spend more (and more), force inflation up further and leaving the US Federal Reserve with no choice but to resume its tightening?
I think there's at least another factor that deserves our attention, one we tend to forget about when we look at events and try to explain them through fundamental analysis: the increasing importance of short term investors in today's markets.
Oil specialists at Smith Barney Citigroup issued a report this week (see "Has The Oil Price Peaked", 19/09/06, for those who are interested) wherein they suggested that certain markets, such as oil, simply can no longer be analysed without taking into account that more than 50% of the price direction is being led by large investment funds.
Maybe these funds are now telling us the peak oil theory is flawed, human entrepreneurialism will find ways to solve the world's oil problem, as long as the markets are allowed to be governed by Adam Smith's invisible hand. Maybe all they're saying is hey, we don't like the outlook of supply catching up with demand, because it means less opportunities to make large profits for us.
Can it be that simple? Or could it be that what goes for oil, also goes for copper, nickel, aluminium and even sugar and wheat? Maybe the key message the large fundies are transmitting is this is the end of an era – right here, right now. The Super Cycle for commodities still has several more years to go, but time has arrived for an intermediate pause. The easy and fast profits have now been made, there's a strong likelihood other asset classes might be better value in the medium term.
(If you're a really cynical character you would obviously argue that the really smart investors already stepped out during the May correction. This is simply wave two heading for the exits, the late-goers).
Of course, all this means that once the dust has settled, resources stocks will be cheap again, while the US economy might soon be accelerating again and China, India, Russia and Brazil still powering along.
If, however, the market is telling us everything is moving down at the moment because the US economy is likely to do so too, the outlook is for a completely different scenario.
No wonder investors' risk appetite is in decline. The odds simply don't stack up.
Till next week!
Your I am not a betting man myself editor,
Rudi Filapek-Vandyck
(As always supported by the Fab Four: Greg, Chris, Terry and Rob)
