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Oil Prices May Indicate Party Time

By    |   Wednesday, 04 July 2012 06:36 PM

One cannot but help ponder about the economic cycles that we are experiencing and what the future holds for us.

In the heat of the July 4th holiday, I sink into deep thought and wonder where the economy will head next and what will be the trigger event that will bring about a break from this funk.

I believe the price of oil has been an excellent indicator for the fortunes of the economy in general. While no one has a crystal ball, I believe the magic number is $98.6.  If oil does not break this level in the next 2-3 weeks, we will see some significant uptick to the market. Currently the signs are indicating that this level may not be breached in a sustained fashion.

We can all imagine what the effect of oil prices have on our economy. We have seen innumerable instances and conclusive proof that, of the many factors that affect the economic growth, oil is one of the key indicators. The inverse correlation between high oil prices and economic growth is well documented in several studies done by banks.

In simple English, when the price of oil goes high, we see a decline in economic activities. When the price heads lower, we see a spurt in economic activities. Of course, there is a lag time between the price of oil falling and the start of economic growth, but this lag time has become more and more compressed.

In the old days (say 15-20 years ago) economic cycles would last 3-4 years between boom and busts. This then compressed to 2-year cycles in the past decade. Now it feels more like 9 months for a cycle to turn.

What this means is that oil prices have become much more of a leading indicator of economic activity than it used to be. The economic growth cycle has become more sensitive to oil-price shocks than before and in a much more real-time effect than earlier.

There is a confluence of events that will likely unfold in the next few weeks that will confirm my views. The first of those events comes this Friday, when the jobs number for June will be released. If the past data and recent releases are any indication, we should see a dismal number and a miss of the majority expectation.

If that is to happen, we will see another surge of U.S. dollar buying and a decline of all risk assets. Currencies and commodities will get sold and Treasurys will get bought. This will bring about additional downward
pressure on the price of oil, and we may test the $80 level again.

The $98.6 price of oil is the 200-day moving average in the past year. If this price is not breached before early to mid-August, we have a clear sign of a shift in the market sentiment against an upside movement.

At this stage, the Federal Reserve will have no other choice but to announce or start preparation for QE3, and then we will have the floodgates opened. But the price of oil will sustain the 200-day average, and we can start seeing the benefits of a surge in economic activity in about two months from August.

What is fascinating is that I am once again observing the market alignment of a Q4 and Q1 surge of economic activities. For the past three years we have observed this trend of good growth in Q4 and Q1 to see the activities fade away in Q2 and Q3. Some people call it the “Lehman Brothers” effect
on the market.

So if you see oil stay below the $98.6 level by mid-August, get ready for a surge in Q4 of this year and beyond.

Also, those of you who heeded my advice and are sitting on handsome profits on the Australian and New Zealand dollars should think of exiting their positions this week to take profits.

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Wednesday, 04 July 2012 06:36 PM
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