[MarkL]

In depth analysis of short term and long term oil price trends by Frank Barbera over at Financial Sense here.

$this->bbcode_second_pass_quote('', '[')P]erhaps the really big questions center on whether the Banking System will survive and whether or not the Dollar will collapse. At present, we believe that a huge Banking System crisis will be seen in the next 18 to 20 months, and that several large ‘mainstream’ banks may end up failing. We also believe that the risk of a Dollar collapse is extremely high, and that an Argentina style Devaluation is brewing up like an afternoon thunderstorm in the tropics. Whether or not a deep recession evolves into a full out Depression may ultimately hinge on how much damage is inflicted on the Dollar as the falling dollar has been pushing up commodity prices over time, and in so doing, pushing down real consumer spending.

Of course, one big question to ponder when it comes to markets is how Oil will fare in an upcoming, perhaps global economic contraction. To this end, with the Oil market showing some signs of near term weakness, we thought we would spend a moment and try to understand where Oil may be headed in the months ahead.

[MrBill]

Well, as bad as the situation in the US is at the moment, we have to remember that they are not the global economy, and demand elsewhere for all commodities, including energy, is still rising.



If there is a US lead global slowdown then demand may not rise as quickly or by as much, but the trend is ever higher. I think the latest stats I have seen from the IEA have been worldwide demand rising by two percent per year, while supply lags at one percent? That is an ever widening gap.



But I would ignore nominal prices in US dollars. With the debasement of the US dollar they really distort the price of crude in any case. Also, financial investment has flowed into commodity prices in general as the last asset class left standing, so this also distorts price. So the price reflects dollar hedging and fears about future inflation rather than true supply and demand fundamentals.



Personally, from a conservation point of view and in the context of changing lifestyle habits and searching for alternatives I think high prices in general are positive.

EUR/USD chart

I think Brent crude will find a near term price support at around 60 euros per barrel. What that works out to in US dollars depends on EUR/USD that is likely to test $1.6000 before it re-tests $1.4000 again. And then only if the ECB starts easing later in the year.

Brent crude in euros chart

[Gerben]

$this->bbcode_second_pass_quote('MrBill', 'i')f the ECB starts easing later in the year.

[MrBill]

The economic fundamentals do not really justify EUR/USD at $1.6000, and even $1.4000 is a very strong euro. Currently you have interest rate differentials supporting the euro as the Fed eases and the ECB sits pat.

But also there is a great deal of negativity surrounding the US dollar itself. There are only a handful of freely convertible, liquid currencies where those outflow of US dollars can go. Some of those markets are very small in absolute terms compared to global capital flows. Oil producers alone may have the better part of $2 trillion this year to reinvest into the capital markets. Ending the GCCs peg to the US dollar would help as well as developing their own domestic economies and capital markets, but for the moment the eurozone remains the favored destination for capital flows not headed into US dollar assets.

That flow dominates economic fundamentals per se. And it is self-reinforcing as inflows force the euro higher. However, growth in the eurozone is decelerating rapidly. France, Italy and Spain have been hit with slowdowns, and even strong growth in Germany is starting to wane.

Meanwhile some central banks like the RBA and PBoC have been raising interest rates to fight inflation. That causes their economies to slowdown as well. With the US in a recession since the end of 2007 growth and therefore non-energy imports are shrinking. This is further reducing demand for commodities. At least potential demand. Allowing supply to catch-up with demand. That should moderate commodity prices, especially if you look at them in a basket of currencies versus nominal prices in US dollars that partially reflect the debasement of the US currency.

The ECB will hold-out until commodity prices start to moderate, but then I expect them to start easing in the second half of 2008 as well. Otherwise they will be burning edifices of Trichet on Bastille Day this summer!

I do not think that easing in line with slower growth and moderating inflation would damage ECB credibility. They have done an admirable job up to now. The best [s]Bundesbankers[/s] central bankers around at the moment.

The injections of euros into the banking system were necessary to ensure liquidity for the banking sector that threatened to seize up. That is their job. And it worked. Interbank lending in Europe seems to be working fine, and all the continental banks that I deal with can now offer funding at lower levels than their US investment bank rivals via cross currency swaps.

The only European banks now that seem to be in dire straits are the ones that are still over-exposed to toxic US debt and derivatives. That was not a systemic problem per se, but one of poor credit risk management on an individual bank level. However, as Deutsche Bank yesterday admited, losses going ahead will be dependent on the housing situation in the USA stabilizing. That is far from a given.

Personally I think the BOE has a bigger problem on their hands than the ECB. They have a shaky housing market, a decelerating economy, budget problems, and higher than acceptable inflation. A weaker pound would just exacerbate those inflation concerns. It is a real mine field for them to navigate.

[Gerben]

MrBill, thank you for your answer. You put a date to it (14 juillet, July 14). I hope I'll remember to check the prices then. I think it would be a good moment to decide in which basket to put my eggs. I think the dollar will continue to go down, but I'm not certain enough to put my money where my mouth is.

[MrBill]

$this->bbcode_second_pass_quote('Gerben', 'M')rBill, thank you for your answer. You put a date to it (14 juillet, July 14). I hope I'll remember to check the prices then. I think it would be a good moment to decide in which basket to put my eggs. I think the dollar will continue to go down, but I'm not certain enough to put my money where my mouth is.