QE3 Will Drive Oil Prices, Too?

by Nigel Bolton-Shaw on October 9, 2012

RiskNet examines whether easing will affect the price of oil. While the argument has always been that supply and demand drives commodity prices, this may not be so true in the era of central banking as it has been in the past.

In an article, RiskNet makes the case that QE3 will be “a big driver for oil prices.”

Here’s a central statement: “Some market experts believe oil is becoming desensitised to fundamental supply and demand changes, such as inventories – as a result, they have made changes to the way they engage with markets … Looking at the effect of QE3 on oil markets will shed light on whether oil is now acting more like a financial asset rather than a supply and demand-based commodity.

In this chart from InflationData.com, we can see how closely prices track various monetary phenomena. Oil prices went down savagely in 2008 when the world’s dollar economy virtually evaporated. But ever since then, prices have been moving back up as central banks dump one stimulus into the market after another.

The idea that oil broadly tracks supply and demand is not borne out by the way the market works. Drilling has been extensively regulated throughout the West. Much oil comes from the Middle East. Despite reports otherwise, Saudi Arabia, the world’s “swing” producer of oil, is far more subservient to US interests, than is commonly represented.

It was the Saudi’s cooperation that created the dollar reserve currency when the Saudis agreed to accept only dollars for oil. That remains the case today.

To its credit, RiskNet seems to come down on the side of monetary impacts when it comes to oil and gas. It cites Société Générale Corporate & Investment Banking (SG CIB) as showing “a steady decline in the impact that fundamentals have on the price of crude oil.”

Here’s some more from the article:

 “I would expect to see an even bigger rise for crude this time, since it [the Federal Reserve] has used the novelty of an unlimited term in its announcement,” says Frédéric Lasserre, founding partner at Belaco Capital, a Paris-based commodities hedge fund.

To account for the changing nature of oil, Lasserre and his team have developed a risk metric called the Belaco Stress Indicator. Using this tool, Lasserre can better adjust the composition of the commodity fund’s portfolio according to which risk regime – risk on, risk off, or risk neutral – the indicator model outputs. Based on the current output of the metric, he says strategies that are allocated to risk on regime will perform better. As a result, he is bullish on crude.

Lasserre’s bullishness for crude oil stems from its current high correlation with equities, he says. This correlation exists because oil is being traded heavily not only by commodity industry professionals but by the financial industry in general. “Among all commodities, oil is most sensitive to the financial environment,” he says.

According to Lasserre, crude oil is now significantly impacted by fund flows from large asset managers who view crude oil as a tool to reflect whether or not there is macro growth. “Clearly, the way oil is traded is related to macro risk on/risk off waves,” he adds.

It seem fairly clear that in the longer term, QE3 will force up prices for oil, equities and precious metals.

What is not so clear is when monetary inflation turns into price inflation – and when central bank tightening will commence.

That will be a point of major inflexion. We may even end up with a new monetary system.

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{ 1 comment… read it below or add one }

offshore company October 20, 2012 at 11:14 am

The roller coaster rise and fall in gasoline and diesel prices over the last few years tracks changes in the cost of crude oil. Those changes are determined in the global crude oil market by the worldwide demand for and supply of crude oil. Weak economic conditions in the U.S. and around the world in 2008 and into 2009 led to less demand, which helped push prices down. With the worldwide economic recovery under way, demand is on the rise again but unrest in the Mideast and North Africa has put supplies at risk. This combination of rising demand and reduced supply helped to push prices higher.

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