The Energy Report for Monday, August 16, 2010

As oil prices hit the lowest levels since July 19th people are starting to realize something I have been saying for a very long time and that is, the price of oil is not acting on its own but is being driven by outside macro-economic forces. I have said time and time again that the price of oil really has been acting as a pawn in the economic recovery and is being driven in large part by economic forces. When the Fed prints more money and the dollar falls and the stock market rises then oil rallies.

As the outlook for the economy gets gloomy, like after the Fed meeting last week, stocks fall, then oil gets hit and goes lower. In other words, the fundamentals of supply and demand for oil are dependant totally on the Fed and the prospects for the economy. Of course when I first started to write about these phenomena, it was met by skepticism by a great many people. Some felt that it was a case of the oil market changing because we hit peak oil or was the byproduct of evil speculators.

Yet in today's Wall Street Journal, they are writing about what has become so clear to many. The Journal says, "From Houston to New York, energy traders and commodity investors are watching a new and unusual market phenomenon: a persistently high correlation between oil and stocks. Crude oil is now influenced more by the stock market than by its own inventory levels or demand patterns. (Something I have said many times) Lately, that lockstep has reached an extreme, with the correlation between crude oil and the Standard & Poor's 500-stock Index hovering around 70%, doubling the average of 34% since 2008."

The journal goes on, "Oil and stocks aren't supposed to swing in sync with each other. Unlike stocks, which are priced off corporate earnings, oil is usually driven by supply-and-demand dynamics. Since oil started trading in 1983 at the New York Mercantile Exchange, the linkage between the two markets averaged a meager 0.1%. Though there have been sporadic spikes, it has never stayed at such an elevated level for as long as it has lately. The typical low correlation causes many investors to include commodities into their portfolios of stocks and bonds to diversify and smooth out swings in their other investments. Oil and stocks started to walk in parallel when the financial crisis erupted, as all markets were jolted by the same broader economic conditions.

Many investors had expected that to be a passing trend. Instead, the linkage has been in place ever since and recently grown even stronger. Last week, this high correlation was a double-whammy for investors who owned both oil and stocks. A 4% selloff in stocks was compounded by a 7% loss in oil prices." They go on, "The influence of stocks on oil became particularly evident in recent weeks as oil managed to rally despite its bearish fundamentals. Stockpiles of crude oil and petroleum products in the U.S. swelled to an all-time high in the week ending Aug. 6, while China, the primary engine of demand growth, cut back on its oil imports. Nevertheless, oil prices have gained 11% since late May." The Journal wonders if speculators are part of the cause,

"Oil and stocks are joined up by actual money flows, as more fund managers start to trade in both markets. Many of them are so-called "algorithmic traders," who trade based on technical signals instead of fundamentals. Meanwhile, the growth of exchange-traded funds that are invested in stocks and commodities make it just a click away for investors to move assets around." The Journal goes on to say, "Oil and stocks also cross paths in the so-called "risk trade." Traders generally think holding speculative investments, including stocks and oil, in a portfolio adds risk, and liquidating them removes risk. When their appetite for risk wanes, they pull money out of stocks and oil; when the risk trade is back on, they apply capital to both assets.

The "risk trade" has reached a fever pitch recently, as traders grow jittery about the economic outlook." Now as I have said before, the reason for these phenomena is the Feds' policy of quantitative easing. The price of oil is being artificially supported under the guise that the policy will create economic growth and thereby energy demand and perhaps down the road, inflation. Of course that outlook is not as certain when the stock market gets weak as it did after last week's Fed meeting. For oil the main fundamental is the Fed and the success or failure of their policies. Oil is in some great ranges! Call for my buy and sell points!! To get a trial call me at 800-935-6487 or email me at to open your account. Also check me out today on the Fox Business Network.

There is a substantial risk of loss in trading futures and options.Past performance is not indicative of future results. The information and data in this report were obtained from sources considered reliable. Their accuracy or completeness is not guaranteed and the giving of the same is not to be deemed as an offer or solicitation on our part with respect to the sale or purchase of any securities or commodities. PFGBEST, its officers and directors may in the normal course of business have positions, which may or may not agree with the opinions expressed in this report. Any decision to purchase or sell as a result of the opinions expressed in this report will be the full responsibility of the person authorizing such transaction.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

Other Topics