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Oil and Gold:
Where do we go from here?
With Eric Sprott, Rick Rule, and Marc Faber
Published February 13, 2015
A Recovery with Soft Oil Demand and Low Wage Growth?
Positive economic data has helped fuel the US stock market over the last year. In January 2015, the US economy added 257,000 jobs according to the Department of Labor.
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New jobs have increased by over 200,000 each month for the lasts 12-months. The US economy grew at an annualized rate of 5% from July to September 2014, according to the Bureau of Economic Analysis, and continued at a clip of 2.6% from October to December.
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With that backdrop of economic growth, oil prices have done something straight out of left field. They got cheaper by half over a period of only about six months. Oil was selling for over $100 per barrel globally last summer. West Texas Intermediate crude, a benchmark for US oil prices, was above $90 per barrel this summer
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and was below $55 per barrel as of late December 2014. As of early February, oil remains below $60 per barrel.
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The oil price is falling while stock prices are reaching all-time highs. That is what you call an elephant in the room. On the one hand, an economic recovery should mean that oil will be in higher demand, as manufacturing, housing starts, and other energy-consuming industries pick up.And yet, the recent price action suggests that oil is becoming less appealing. What should you make of it?There is evidence that part of the reason for lower oil prices is an increase in supply due to higher oil production, particularly in the US. Global oil production rose from 84.9 million barrels per day in 2009 to 90.1 million barrels per day in 2013
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. As you can see, worldwide oil production has increased steadily over the last 3 years.
CHART 1: GLOBAL CRUDE OIL PRODUCTION – DEPARTMENT OF ENERGY
1 0 0 0 B a r r e l s o f O i l
500062507500875010000
2015-01-022014-01-032013-01-042012-01-062011-01-072010-01-29
Source: Bloomberg
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Why did this three-year old trend suddenly spook the market?Many analysts and economists have suggested that a lower oil price will not last, as consumers will take advantage of lower prices to use more oil and thus dispatch with excess supply. So far, we have yet to see this occur.Oil traders view the oversupply as so severe right now that we have entered a situation known as ‘contango.’ The price of oil for delivery a few months from now is higher than the current spot price. As a result, traders buy oil to stockpile, which they immediately sell on the futures market to lock in a profit. Partly thanks to the ‘contango’ trade, oil stockpiles in the US have skyrocketed.So far, neither the boost to consumption expected from a lower price, nor the reduction in current supply due to US stockpiling appear to have firmed up the price of oil very substantially.While the oil price decline has been blamed on surging supply, production growth has been steady over three years, and was of little concern for most of that period as prices remained comfortably around $90 to $110 per barrel. Meanwhile, the global economy – and particularly the US – are supposed to have improved. If so, why isn’t oil in higher demand?
A Lower Oil Price Confirms What Interest Rates Suggest
Low interest rates support the idea that the world economy is slowing down. In a real boom, consumers and investors around the world tend to deploy more capital into assets like businesses or new housing starts, a move that drives up interest rates. Yet, lower and lower interest rates suggest that these investors are hunkering down, instead of ramping up.The Federal Reserve offers a feel-good take on low interest rates – that they help the economy. This might be true, if there were substantial demand for credit and places to re-invest using this huge supply of capital. In the absence of beneficial uses for this cheap credit, low interest rates are more a symptom of a tepid economy, rather than an aid to an economy that appears to have little use for them.An important misconception among analysts and economic observers is to suggest that low interest rates are set by the Federal Reserve, and that other aspects of the economy depend on these interest rates. Remember, though, that the market exerts a strong force on interest rates – one that might very well be overwhelming. The Fed is certainly taking advantage of weak credit demand to help fund the government cheaply, but the reasons for low interest rates may be more deeply-rooted than the Fed’s policies.
CHART 2: US CRUDE OIL INVENTORIES EXCLUDING STRATEGIC PETROLEUM RESERVES – DEPARTMENT OF ENERGY
350000360000370000380000390000400000410000420000
Jan 30, 2015Jan 03, 2014Jan 04, 2013
1 0 0 0 B a r r e l s o f O i l
Source: Bloomberg
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In fact, interest rates might go even lower if the Fed did not discourage holding cash by producing heavy amounts of new dollars and expanding their balance sheets.In other words, low interest rates may simply be caused by much lower demand for capital and debt. Along with a weak oil price, weak interest rates suggest an overall sluggish economy, not a broad recovery.
Weakness Around the World
The oil price is driven by the same dynamic that underpins the case for most commodities, such as copper, uranium, or iron ore.As people get richer, especially in emerging markets, they tend to consume more metals with which to build houses and cars, and more fuels to generate energy and power machines. Yet commodities have been flat since the Great Recession ended, suggesting, once again, that economic growth is slowing down.The price of copper is at a four-and-a-half-year low of $2.60 per pound
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. Uranium sells for $36 per pound today, down from around $65 in 2011.
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Iron ore for delivery in 2015 trades for below $60 per tonne on the futures market, down from over $180 per tonne in 2011.
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The price of oil, meanwhile, had not declined substantially over the last three years. Perhaps its recent price collapse is not as sudden and inexplicable as many believe. Indeed, a low oil price is consistent with the price action we’ve seen in other commodities. It also dovetails with economic data we’re seeing from around the world, which suggest that global growth rates are simply decreasing.The Eurozone is trudging along more slowly than the US, according to statistics from the European Central Bank.
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In the third quarter of 2014, its GDP was nearly flat at 0.3% in growth. Inventories were being dis-hoarded, falling by around 15 billion euros over the last 6 months. This suggests that fewer goods are being produced and stockpiled – a response to weak demand. Employment grew by 0.2% over the quarter, meaning that unemployment levels are still high for the developed world, and industrial production increased by only 0.1%.The situation is similar in Japan. Despite sustained ultra-low interest rates and activist policies meant to stoke growth, the country is mired in what isn’t far off from being a depression. Its GDP shrank 0.5% in the third quarter of 2014, right on the heels of a more than 1.5% contraction in the second quarter.
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Developed-world economies are not the only ones that are experiencing weakness now.China’s annual growth rate has slowed from around 10% in 2011 to around 7.5% as of the third quarter of 2014.
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Its domestic consumer market appears subdued. In the third quarter of 2014, the Consumer Price Index (CPI), which measures the average change in the prices of consumer goods and services, was its lowest since February 2010. The real estate market has been weak and domestic investments in fixed assets – which includes new building projects – grew by only 16.1%. That number was above 21% in early 2013, and has been declining steadily ever since.Weak economies around the world offer weak demand for commodities and for capital. The effect is to keep interest rates extremely low and to push commodity prices down. The same logic applies to oil, which has long been priced with the expectation of ever-increasing demand and ever-declining supply. We can therefore view the oil price as a symptom of poor global economic growth, which is a long-term problem – and not just as a short-lived consequence of a slight oversupply of oil.Falling oil prices are yet another sign that the world economy may be more fragile than before the Great Recession. Why is this important? Well, many write off the oil price drop as merely the machinations of Saudi Arabia to throw a monkey wrench in the wheels of the US shale industry – or perhaps a market that’s over-reacting to a slight supply and demand imbalance. You would then naturally expect a quick recovery after the market worked through the problem of oversupply, or once OPEC and Saudi Arabia had adequately bludgeoned its rivals. On the other hand, if you attribute the oil price decline to a more significant underlying issue within the world economy, then the oil price drop starts to look like the harbinger of a more long-term trend.
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