While everyone has been following the drama surrounding the price of oil falling since the most recent peak this summer, currency markets began feeling the effects of the turmoil more recently. We reported earlier a likely return of volatility in equities and forex markets more or less coinciding with the end of Quantitative Easing in November. After one last hurrah in mid-November, it would appear that volatility has in fact returned to markets and we are seeing the impact that has on asset prices: in most cases… downward.
What to Make of the Downward Price Movement of Oil
Oil is a very politicized commodity globally. Every once in a while the price rockets up somewhat out of control as speculators pile in during high-demand periods. Marginal producers find it economical to begin production from less-economical fields. For a while the global oil cartel tolerates this until socio-economic forces push end-consumers to cutback use (or at least slow growth rates) and demand begins to level or fall. One can see some of the demand for end use material in the St. Louis Federal Reserve “miles driven” chart – which cratered in 2008 post-Lehman and has basically flat-lined since (with gasoline demand falling with rising prices and greater fuel efficiency in vehicles).
It takes quite some time for large macro-moves to show up in asset prices – and when they do start to hit (like the fall in oil prices in summer 2014) and suppliers don’t react to keep supply/demand in balance… you get what we have been seeing the last few months: falling prices. The lowest-cost producer (Saudi Arabia) is perfectly happy to keep pumping oil at these reduced prices as it will ultimately force less economical operators out of business… whereupon we’ll start to see prices rise again. This process will take some time however, as the marginal players will try to continue to tread water until they drain their capital reserves. Smart money people are saying this process will take 12-18 months before we’ll see a substantive rise in oil prices again. In the meantime this will cause instability in markets in which oil is a crucial export.
How the Carry Trade Is Impacted by Cheap Oil
One of the more important carry trades of the last decade or so has been the use of cheap USD or forex credit to speculate in oil markets. Rumors of a major player / trader going bust are just one example how of the end game shakes out when demand growth fails to materialize. Long-time readers know all to well how markets are layered / levered up and stacked like dominos: a failure in one market (if big enough) begins a chain-reaction in other markets. That is what we are seeing in the carry-trade. Asset prices have fallen in one key speculative trade, forcing multiple parties to unwind. Suddenly can’t miss investments in oil-exporting nations become too risky – causing more traders to cut their risk level. Similarly the threat of capital controls in exporting countries prompts further speculative risk reduction. Risk reduction (for those of you who don’t know) is just a fancy way of saying, “SELL! SELL! SELL!” without trying to draw attention to the fact you are selling.
If you hadn’t noticed lately… lots of folks engaged in the most speculative trading positions… are doing LOTS of selling. Here’s how it looks in the G7CTI… note the mid-November peak, just prior to the capitulation of WTI and Brent Crude prices. It’s been just about all downhill since.
Is Political Instability or Economic Instability the Endgame?
It is also worth noting that Chinese and Russian forex ties and attempts to trade oil in Rubles and Yuan (hence ending / curbing Petrodollar domination / influence) may also be playing a role in the motivations of the top exporting nations.
From my perspective – this is not about using soft demand to shutter a handful of marginal shale operators in the US. This is about geo-political policy and maintaining global influence and power, with all of us peons hoping the heck world leaders know what they’re doing.