Tags: Investors Must Tread Carefully Amid Volatile Oil Prices | Euro Debt Crisis

Investors Must Tread Carefully Amid Volatile Oil Prices, Euro Debt Crisis

By Hans Parisis
Tuesday, 06 Mar 2012 01:59 PM Current | Bio | Archive

Speaking to the American Israel Public Affairs Committee (AIPAC) in Washington on Monday, Israel’s Prime Minister Benjamin Netanyahu stated: “Israel has waited patiently for the international community to resolve this issue. We’ve waited for diplomacy to work. We’ve waited for sanctions to work. None of us can afford to wait much longer.”

At the same occasion, the Israeli prime minister invoked the Holocaust in saying he wouldn’t allow Israelis to “live under the shadow of annihilation.”

From his side, Yukiya Amano, director general of the International Atomic Energy Agency in Vienna, said during the closed-door quarterly board meeting of the 35-nation IAEA board of governors: “We have our credible information that indicates that Iran engaged in activities relevant to the development of nuclear explosive devices.”

That said, I think investors shouldn’t discard anymore the growing probability of a strike on Iran. They should start preparing for the impact that such an event could have on the price of crude oil and its “collateral” damage to global growth as well as to the equity markets.

It’s a fact that most of the time, stocks and crude oil prices are positively correlated whereby both respond to upward and downward revisions to the outlook for growth and demand.

Nevertheless, it’s also a fact that harmonious relationship stops abruptly when crude prices rise sharply, especially when such moves are “supply” related.

Since February 2003, equities have responded negatively on eight occasions to movements in crude prices when the relationship between stock and crude prices switched from benign positive to rather more negative and higher oil prices, and thus expenditures on crude, had a negative impact on stocks.

The three most recent such moves were in May 2007, the summer of 2008 and during the first half of 2011. Please remember that in 2008, crude prices weren’t driven by a supply shock but rather by demand and speculation.

Today, we also see important speculative positions in the oil market. Data from the U.S. Commodity Futures Trading Commission (CFTC) show non-commercial positions have currently $31.5 billion of long positions in the asset class, which is actually the second-highest number since the first half of 2011 if we go back as far as to 1995.

It’s also noteworthy that we have the forward crude oil price curve, especially the Brent crude oil price, showing lower crude prices on dates in the future.

At Monday’s close on the NYMEX, crude oil Brent for the last day of November, quoted $118.93 while last day of April quoted $123.80, which is nearly four percent lower than the price at the end of the year. On the contrary, crude oil WTI (West Texas Intermediate) forward price curve was practically flat at around $107.50. So, it’s not demand that’s underpinning the actual oil prices but speculation and fear the situation with Iran could take a turn for the worst.

Only time will tell if fear and speculation now are justified.

Let’s hope it isn’t, because if that would be the case, then we we would have a big problem on our hands anywhere in the world, except, albeit limited, in the oil producing countries.

I think for investors who are inclined to “expand” their investments in the oil sector, there is clear evidence it remains attractively priced given current fundamentals.

Maybe it also could be not such a bad idea to use the sector, in part, as a hedge against the current threat of “further” rising oil prices and the negative impact it could have, of course if that happens, on the equity markets.

So, with further rising oil prices that can't be ruled out at all and the European sovereign debt crisis that still has no satisfactorily end solution in sight, I would remain very cautious.

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