Week End Blog – OIL!

This week was all about oil prices. After a price collapse of over 30% since the middle of June, oil lost another 6% as OPEC decided not to cut production levels. I guess the market reacted in line with expectations, sending oil price futures significantly lower. This has become a pretty impressive bear market in oil.

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Historically, the end of the year has always been a difficult period for oil, with, on average, falling prices during the whole last quarter. If history is any guidance, the oil price will have another difficult month ahead.

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One obvious victim of falling oil prices is Russia. Break-even prices to prevent budget deficits are long gone and the ruble has, again, come under severe pressure. This year alone the ruble has lost 50% of its value against the USD.

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Lower oil prices are also a very worrying sign for GDP growth going forward. While Bloomberg consensus still thinks recession could be avoided, more and more negative outlooks are coming in. Russian asset manager Renaissance Capital predicts that at current oil prices Russian GDP will shrink 3% and a hefty 6% if Brent were to fall to USD 50.

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In most parts of the world oil prices are mostly related to lower inflation. On the back of very modest price increases in the Eurozone the German 10-year bond yield reached a fresh all-time low of just 0.69%. In terms of interest rates Germany is way ahead of Japan in becoming Japanese.

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But interest rates are falling to incredible low levels everywhere in Europe. This week France became the next country in which the 10-year government bond yield fell below the 1%-threshold. Big budget deficit or not, investors keep piling into European government bonds.

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Spanish bond yields also reached a new low, below 2%.

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And even Italy, the new sick man of Europe, reached record low interest rates this week. That Italian unemployment is still rising, and that the speed at which this happens is increasing, does not seem to matter. The ECB is going to have a very difficult task ahead in getting inflation higher.

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But, there is, of course, one big beneficiary of lower oil prices. Consumers all around are getting a massive oil-related ‘tax-cut’, which will increase their disposable income. US gasoline prices have fallen dramatically and the share of income used for fuel is coming down quickly. It has been calculated that a drop of 1 cent in gasoline prices give US consumers roughly USD 1 billion spending power. So far, gasoline price fell over 70 cents already.

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Next to consumers, most company profits are also fueled by the lower oil prices as energy bills go down. Lower cost levels could push this mega-rally on equity markets just a bit further. Especially since the risk premia in most other asset classes, predominantly fixed income related, have been collected already.

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There is one thing to keep in mind though. Warren Buffet’s most favorite equity market graph is not looking all that healthy anymore. Total market cap now stands roughly at 150% of GDP, which is high in historical context. There are no cheap asset classes left anymore it seems… Perhaps it’s oil?

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Thanks for reading the Week End Blog and enjoy your weekend.

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