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Mutual Funds - Mutual Funds.
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Posted by Monitor on June 12, 2009, 4:02 am
$75 Oil Will Kill The Economic Recovery Dead
Friday, June 12 2009 By Dirk van Dijk, CFA
Will Rising Oil Prices Prevent a Recovery?
The following two charts (and the comments in between them) are part
of a very interesting article by James
Hamilton. The collapse in oil prices last fall acted as a key economic
stabilizer and helped ameliorate the
economic decline.
It showed up in two key places. The first was in the trade deficit
numbers, which have shown a very dramatic
improvement over the last year (see here and here). The other place it
showed up was in retail sales, since a
dollar spent at the gas pump is a dollar that can not be spent
elsewhere.
Since last Christmas, prices at the pump have climbed sharply, as
shown in the first graph. While prices are still
far below the levels of a year ago, the current levels are high enough
to start hurting, especially those who have
seen their incomes drop due to the recession. Dr. Hamilton calculates
that the current prices would be consistent
with energy taking up over 6% of total personal consumption
expenditures, up from 4.85% back in December.
As the second graph shows, that would be about the share of spending
energy had back in the mid-1980=92s. The mid-
1980=92s were not exactly the worst period of our economic history, so
such a level in and of itself should not be a
real problem for the economy. And we faced a far more serious problem
with energy prices in the 1970=92s than we did
even at the worst energy price levels we saw a year ago.
Still, this is coming at a time when the economy is still very
fragile. Retail spending on goods other than energy
face strong headwinds from both the need for consumers to rebuild
their personal balance sheets (pay down past
debts and build up savings) and from much worse personal income
statements (unemployment, hours and wages cut,
lower interest rates on savings). This is just one more unhelpful
factor that will pressure sales, particularly for
stores that sell discretionary items, including clothing stores like
The Gap (GPS) and appliance stores like Rex
Stores (RSC) and HH Gregg (HGG). Higher oil prices are of course good
news for the energy sector, but for the
overall economy high energy prices are a significant negative.
The rise in oil prices does not seem to be consistent with the overall
weakness of the world economy, but there are
several reasons why it just may be sustained or extended, even in the
absence of a global economic rebound. The
first is that oil is a good hedge against future inflation, and given
the expansion of the Fed balance sheet, that
may be a very serious concern down the road. Currently the bigger
threat is deflation, but it will be hard for the
Fed to sop up all the liquidity that has been created to fight the
deflationary fire.
A second and somewhat related reason is that China has been increasing
its purchases of all sorts of commodities,
trying to take advantage of the lower prices (note that the price of
other commodities like copper have also
increased sharply from the lows of last winter, but remain well off
the highs of last summer). OPEC has also shown
greater discipline this time around than they have in the past. How
long that will last nobody knows, but so far
they have been keeping it together.
The third reason is that the looming danger of peak oil has not gone
away, it has only been masked by "peak demand"
caused by the economic downturn worldwide. Any incremental oil is now
coming from very expensive sources like the
Canadian oil sands or the very deep waters of Brazil, both of which
require oil prices in the mid-$60=92s to be
economically viable.
With oil prices rising above those levels, the drilling off Brazil
should pick up steam. There are, however, very
few rigs capable of drilling at such depths. Most of those are
controlled by two firms, Transocean (RIG) and
Diamond Offshore (DO), both of which will benefit enormously if oil
prices stay high.
In short, the current levels of oil prices are not exactly fertilizer
for the "green shoots," but will not kill
them off either. Other developments, such as long-term interest rates,
will have more of an impact. The very low
prices at the pump in the first quarter may have been one of the key
reasons why consumer spending in the quarter
was higher than expected (but probably not as big a factor as
increases in transfer payments). However, if they
continue to rise towards the $100 level, the world economy could
easily fall back into the abyss
The 16% increase in gasoline prices between December and February
resulted in an additional $37 billion spending by
consumers at an annual rate on gasoline and fuel oil, increasing the
share of energy purchases in consumer budgets
from 4.85% in December to 5.17% in February. The additional 40%
increase we've seen in the retail price of gasoline
since February has likely brought that expenditure share back up above
6%.
Read more :
http://www.etfresources.com/article/142428-will-rising-oil-prices-prevent-a=
-recovery
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