Welcome To Peak Oil

The term “peak oil,” per Wikipedia, is the point in time when the maximum rate of extraction of petroleum is reached, after which it is expected to enter terminal decline.

To yours truly, it refers to the point in time at which oil prices must begin to decline lest their effect on inflation become problematic. Today is that day.

To understand the significance, we have to go back to Jul 2014. USDJPY, the primary driver of stock prices via the yen carry trade, broke out (yen declined) after a protracted consolidation [for more: see What Really Drives Stock Prices?] Having the yen rapidly drop in value might have produced inconvenient inflation in Japan, which imports all of its oil.

Fortunately, there was one simple way to cope with it: crash the oil market. As the chart above shows, the two events were simultaneous. CL plummeted from 107 in Jun 2014 to 26.05 in Feb 2016 as USDJPY shot higher.

When USDJPY reached 126, however, it ran into overwhelming overhead resistance and began a precipitous decline. Stocks, which had relied on an ever-rising USDJPY, were not amused.

In fact, every time USDJPY dipped below the critical 120.11 level (dotted yellow line below), SPX fell off a cliff. The Powers That Be needed a new way to prop up “markets.”

To TPTB’s delight, they discovered they could manipulate the price of stocks as easily with CL as they had with USDJPY. Remember, a dropping USDJPY means the yen is appreciating.

So, rising oil prices were acceptable to both Japan and the US which, given the recent declines, had plenty of leeway to allow prices to “recover.” Indeed, a recovery was necessary in order to prevent another round of bank failures.

On Feb 11, CL bottomed as expected at 26.05 and nearly doubled over the following four months. Stocks also recovered sharply, even as USDJPY dropped like a rock.

By now, you might be thinking “this is all well and good, but what does it have to do with peak oil?”

Simply put, today marks the one year anniversary of the beginning of CL’s last plunge: from 50.92 on Oct 9, 2015 to 26.05 on Feb 11, 2016. With CL currently at 53, every tick higher will theoretically manifest in higher inflation (year-over-year.)

Again, inflation would be a most inconvenient development for central banks which have used the threat of deflation to justify quantitative easing and other unprecedented intervention in financial markets.

From here on, TPTB must either: (1) resign themselves to higher inflation going forward, which would ultimately necessitate higher interest rates and thus crash equity markets; or, (2) rev up the yen carry trade again; or, (3) find a new carry trade to keep equity prices on the rise.

Is it any surprise that USDJPY recently broke out of the falling red channel it’s been in since Oct 2015?

We remain long from 2147.65 on Oct 4, with last week’s upside target price unchanged.

econintersect.com