This unprecedented action is meant to
prevent deflation, stave off a double dip recession, encourage
consumer spending, spur business borrowing and keep equity prices
(the stock market) propped up. This announcement happened in early
August, just after the congress and the president agreed to a
stop-gap measure to raise the US debt ceiling. Market reaction has
been mixed (actually more like schizophrenic) with oil and equities
plummeting on some days and rallying hard on others. In my opinion,
at the heart of the uncertainty is that Markets are beginning to
distrust Sovereign Debt (money borrowed by governments). This has
led to a destabilizing of capital markets. The one constant in all
this is that the price of gold continues to surge, a sure sign of the
deep-seated fear of economic uncertainty.
Prices have now fallen below the $90 per barrel
range and the price drop we are hoping for may be around the corner.
What could cause oil to continue its pull back?
In short, continued slow economic growth both here and abroad. Even
China’s economy is showing signs of weakness. Specific factors
include : Continued lower demand for oil; Continued erosion of
equity prices in the US stock markets; Stability and a resumption of
oil exports in Libya; Action by the CFTC to curb speculation; A
reversal of fed policy regarding the extreme low interest rates they
offer the big banks (don’t hold your breath on those last two).
What could cause oil to rally back up? Signs that
economic growth is about to pick up either here or abroad; Strength
in the Euro (not too likely as they have a whole basket of countries
in distress); Disruption of supply; Hurricanes heading toward the oil
regions in the Gulf of Mexico or refineries on the East Coast.
If I had to guess which way oil is going to
go, I would say there is more of a downward bias but at the end of
the day there is no sure way to know. Oil can rally or sell off in a
matter of hours in a way that is truly incomprehensible. The daily
ranges of pricing can be over 10 cents per gallon.
All this volatility leads me to believe that a
fixed price with downside protection is the safest bet to hedge your
oil needs. Look at it like this: If you lock in without downside
protection you are making a bet that oil will rise, if you don’t
lock in at all you are betting that oil will fall. If you lock in
with downside you are hedging your bet. Not only that, but you
are quantifying your risk at $.25 per gallon.
At some point (2 years?) interest rates will rise.
The Federal Reserve will not be able to keep lending at the
“discount window” indefinitely. Higher interest rates will be
needed to attract investors in government debt, and the Fed will
eventually have to start to sell the massive amount of Treasury
securities that it owns. When either event starts, commodity prices
will fall. The European Central Bank has started to raise rates to
fight inflation, but the US Fed is steady with easy money.
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