According to the prevailing wisdom of the finance media and it seems most market analysts, the fall in the price of oil has not only been sudden but also unexpected. I suspect much of this has to do with a number of people trying to deflect attention away from their earlier bullish calls and it’s amazing how many market bulls have now morphed into long-term market bears. Unfortunately for them the process has not been a total success and if you look closely, you can still see their horns.
The most surprising aspect about the fall in oil prices has been how severe it has been and also how long it took for it to start reflecting weak global economic growth. Copper for example has been trending downwards since July (and before that 2010) – so it shouldn’t be a shock that eventually oil (and gas) prices were going to be dragged lower especially since a lot of new supply has come on-line.
Now that oil prices have fallen, the finance media is awash with “what if” stories with variety of doom & gloom forecasts. But my suggestion (as always) in such times is to relax, look at the facts and then try and make some calm observations about what has happened.
So let’s start off by looking at the oil price chart.
Crude Oil Price 2009-2014
If we ignore the peaks and settle for a current oil price of around $60, then the crude oil price per barrel (in USD) has fallen around 45% recently. That’s nasty, but let’s remember that above say $100 oil was a bit pricey anyway so I’d suggest a price around $80 was (and is) reasonable taking into account current global economic conditions.
Therefore I consider what has happened is that the price of oil has corrected from a level which was too high and has now possibly over-corrected to a level which is too low. I would also hasten to add this type of sharp correction also the stock market sometimes and it’s not uncommon for a market (or a stock) to move from being too hot to being oversold in a matter of weeks.
But 40-45% is a huge correction you might say and it came from nowhere without any warning! My reply to that proposition would be…humbug!
I have almost lost count of the times I have mentioned the Baltic Dry Index (BDI) and warned investors to take note of its weakness as it was a sign that all was not well with the global economy. Yes there has been and is still, an oversupply of ships that carry bulk dry goods – but with the Baltic Dry Index down -60% this year this is an indicator that is almost screaming that global economic growth is stalling.
Of course you probably haven’t heard much about this from the business & finance “experts” in the Australian mainstream media. This is largely because they don’t venture much past RBA media releases, excitable comments about house prices and some lazy analysis of the stock market which seems focused on stocks they hold in their superannuation funds.
But as I have stressed on a few occasions, the Baltic Dry Index is a much misunderstood and maligned economic indicator but is definitely worth watching!
Having said that, the BDI can be a pretty erratic index to follow as shown by the chart below.
Baltic Dry Index 3 Year Chart
I generally look at the BDI in one or two year blocks and filter out any short term peaks and troughs. So as it stands now the trend over the 12 months has certainly been downwards and looking forward, I don’t see much that makes me all that optimistic either. My guess at this stage is that the BDI will find a short term bottom yet again and probably be on the rise early in 2015. At that point it will be time to see if it can clear and remain above the 1,000 mark.
Copper on the hand is generally a widely watched economic indicator but it seems to have been overlooked during the last few weeks as oil stole the show.
Clearly the copper price hasn’t been hit as hard as oil recently, but it is down more than 30% from a high it reached in early 2010. Therefore we could conclude that copper has effectively already undergone a price correction.
Other commodities such as LNG and coal have also undergone price corrections so realistically was it a surprise that the price of oil also fell? I don’t think so.
So rather than panicking or starting to contemplate the long term consequences of oil at say at $20 a barrel, I instead expect that the oil price will soon find a bottom (it may already have) and then start to recover in early 2015.
Yes the severity of the price correction was a surprise, but not the fact that the price itself corrected. As evidence mounts that Chinese economic growth is probably slowing quicker than expected then prices for many commodities are likely to come under continued pressure in the months ahead.
This article was written by Greg Atkinson who is the Managing Director of Ohori Capital. Greg is from originally from Sydney but now works and resides in Japan. He can be followed on twitter via GregAtkinson_jp