Like the rest of the investment world, we've been a'gaggle with the price of oil of late. Not that crude at $100 a barrel is a magic 'red line' in the Sahara Desert that possesses intrinsic meaning – it plainly doesn't. But the speed of the rise, and the subsequent stall in equity markets does point up the fragile relationship between surging energy costs and a global economy that, at the end of the day, is still in the early stages of recovery.
Other commodities, too, have to be examined in this light. When nearly every important futures contract, from softs to metals, has risen at least ten percent in the last quarter, one has to worry about an imminent 'choke' effect. That is, at what point do rising costs take a meaningful toll on consumer and industrial purchases, and in turn, on overall growth?
Amid those questions, one thing is clear. Today's 'energy crisis' is not the same as the ones experienced in the early 1970's and early 1980's. Take a look here:
The above chart represents the developed world's expenditure on energy and food as a percentage of total expenditures and income. Clearly, the last decade has witnessed a rise in that percentage, but relatively speaking, against both income and expenses, we're still paying just a little more than half of what we did back then for food and energy.
Which may speak to our ability to weather the pain of even higher prices.
Cheap, Cheap Money
Another factor pointing toward potentially higher commodity prices is interest rates, which are prodigiously lower today than they were during those two earlier oil blowups. That is, cheaper money is now available to buy the more costly commodities we need to live and do business with.
That said, the current recovery – after one of the most painful recessions of the last century (and in terms of lost jobs, maybe the worst)– is clearly not vigorous or mature enough to cope with ever-climbing oil and food costs. The market itself is transmitting that message, having stalled for the last three weeks in the face of crude disruptions from Libya, supplier of no more than three percent of the world's total output.
Here's how it looks graphically:
The most recent trade in the Dow Industrials (blue channel), and the United States Oil Fund ETF (NYSE:USO, in red), make clear the difficulty that financial markets are having with the prospect of spiking oil.
The investment world is now assessing the strength of the economy to digest the current commodity price rise. And over the next few weeks, we'll find out if it brings her a warm feeling in the tummy, or a bout of painful indigestion.
So, have we reached our pain threshold? Hard to say. But certainly the latest action in oil has been the only thing in the last half year capable of braking the Dow's headlong locomotion toward the firmament.
Call the Doctor!
Perhaps the best answer to the question of whether the global economy is able to cope with the latest oil surge comes from the commodities themselves.
Dr. Copper, as the metal is often endearingly dubbed (because of its ability to diagnose the economic future), is now also transmitting a message of its own.
Have a look at copper's ascent over the last two years:
This PhD in economics made good work of predicting the latest round of global growth. But what's she saying now?
A three month head and shoulders formation may have just been confirmed on the downside, with the neckline and the last retracement low both being cut just yesterday. Copper is now down ten percent in three weeks.
This could spell trouble.
Can we make a buck off it?
Don't swear. If copper's contracting then there are definitely some trades out there that make sense. But first take a look at the five year chart with the COTs beneath.
Commercial shorts are now more negative on copper than at any other time in the last half decade. Remember: these are, for the most part, producers selling their future production to the market at what they consider inflated prices.
If you believe they have some insight into the matter, you might consider a PUT position on companies like Freeport McMoran, BHP, Rio Tinto or Southern Copper.
Many happy returns,
Matt McAbby, Senior Analyst, Oakshire Financial
