After more than doubling since the start of the year, gasoline prices show signs of topping. This would boost consumer sentiment and could help with the budding economic recovery.
Retail gas prices have been rising steadily, advancing daily for nearly two straight months into late-June. Finally, the AAA Daily Fuel Gauge Report reported a break in the trend on June 22 after the average price of a gallon of gas peaked near $2.70 a gallon.
While this was well below last summer’s record of $4.11, rising unemployment and falling income levels make it more difficult for consumers to accept higher prices.
Prices at the pump rise and fall in line with the futures contracts traded on financial exchanges. These contracts are used by hedgers, such as oil companies and gasoline retailers, to lock in a price at some point in the future. Oil companies may sell for future delivery when they think prices are likely to decline in the future; gasoline stations will buy now if the think prices will rise.
The constant changes in supply and demand and the dynamic opinions of market participants drive prices lower and higher. Prices at the pump tend to follow the trend of the futures contract and we generally see retail prices about $0.50 to $0.75 higher than the futures price in the next month.
Looking at recent action in the futures market, there is room for optimism that prices may decline in the short-term. After climbing more than 110 percent since the end of December, prices fell almost 15 percent in less than a week.
What makes this decline especially promising is the fact that it occurred from an overbought extreme. Market analysts refer to a market as overbought when it seems that everyone who wants to buy has already bought. With few buyers left, prices often fall from these levels.
Gasoline futures reached a technical extreme last seen in February 2003. At that time, prices had been moving steadily higher for more than a year. After becoming dramatically overbought, as the market is now, prices fell by almost 40 percent in two months.
This is bearish for gasoline prices but bullish for consumers, and might just be the best news that Ben Bernanke and Tim Geithner could get.
Analysts have calculated that a 10-cent decline in the price of gas at the pump is equivalent to a $145 billion economic stimulus. Futures markets may be signaling that the recovery could pick up steam as consumers benefit from the actions of the market.
Another important byproduct of falling gas prices is rising consumer sentiment. The price of gasoline was shown to be directly related to changes in consumer sentiment in a recent research paper.
That study found that a 20 percent increase in energy prices would historically be followed within two months by a 15-point drop in consumer sentiment and a 1.4 percent decline in real consumption spending. A similar relationship exists for declining prices.
Rising sentiment is a requirement for sustained recovery. And the markets may be doing what the government has thus far had difficulty doing — inspire confidence by posting good news in front of us at America’s 117,000 gas station.
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