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Broadgate: Market News 31/3

31 March 2012

Global – Recent improvements in the global economy are “very fragile” and an escalation of the eurozone crisis remains the most immediate concern, IMF deputy managing director Naoyuki Shinohara said on Tuesday.

While indicators had last year pointed to a big setback for the world there have in recent weeks been modest signs of improvement and stability in the key U.S. and European economies, he said in a lecture at a university in Bangkok.

“Important policy actions carried out by European policy makers have helped and most recently the agreement on a new programme for Greece … has also brought some relief,” he said. But, he said: “There is no room for complacency. A lot more needs to be done to give a fresh boost to growth.”

U.S. – U.S. stocks started the week positively after Federal Reserve chairman Ben Bernanke hinted that the U.S. central bank would keep in place its supportive monetary policy.

Speaking to economists in Virginia, he said the job market remained weak despite three months of strong hiring.

The Fed needed to “remain cautious”, he said, which many analysts took as a sign that interest rates would stay at record lows until 2014.

The S&P 500 climbed 1.4percent to 1,416.51 on Tuesday, its highest close since May 2008.

Meanwhile, Gold prices steadied around two-week highs on the same day, boosted by expectations that U.S. interest rates will stay lower for longer.

U.S. – The number of Americans seeking unemployment benefits dropped last week to the lowest level in almost four years, adding to evidence of an improving U.S. labour market.

Companies are retaining workers and hiring as sales pick up along with confidence in the expansion. The pace of employment has gained momentum in the past three months, helping drive income growth that may ease the strain of higher gasoline prices.

“The labour market is still improving at a modest pace,” said Russell Price, senior economist at Ameriprise Financial Inc. in Detroit. “Across almost all sectors, companies have shed as many workers as they possibly can. Now, they’re responding to the modest improvements in demand.”

Russia – Russia’s finances would be severely damaged by a sustained fall in oil prices, according to the credit rating agency, Standard and Poor’s (S&P).

It estimates that a USD10 a barrel fall in the price of oil would reduce government revenue by USD26bn. The agency says Russia needs an average price of oil of USD120 per barrel to balance its budget this year.

If the price was to fall to USD60 a barrel then S&P says it would have to slash the country’s credit rating.

S&P says that oil is likely to remain above USD100 per barrel but said there is a chance of a steep decline.

“It is worth noting that only slightly more than two years ago the average oil price was actually USD60, and one year later the price averaged slightly below USD80,” said S&P credit analyst Kai Stukenbrock.

Australia – Australia’s mining boom is just the “first taste” of Asia’s ascendancy, Treasurer Wayne Swan said on Wednesday, with the region’s new prosperity expected to transform the global economy.

Australia’s chief economics minister said the shift of power towards Asia would have “truly enormous” implications for his country, which would find itself on the door-step of almost two-thirds of global GDP by 2050.

Surging resources exports to fast-growing China and its neighbours had recession-proofed Australia during the global financial crisis, and were expected to buoy it into the future, Swan said in a speech.

Asia – Asian policy makers are preparing to double a USD120bn reserve pool to defend the region against shocks, reducing their reliance on traditional backstops such as the International Monetary Fund as Europe saps resources.

Officials meeting in the Cambodian capital of Phnom Penh this week will discuss boosting to USD240bn the so-called ‘Chiang Mai Initiative Multilateralization agreement’, a foreign- currency reserve pool created by Japan, China, South Korea and 10 Southeast Asian nations that took effect in 2010.

Asian nations, holder of more than half of global reserves, are looking within themselves to protect the world’s fastest- growing region as Europe and the U.S. struggle to recover from the worst economic slump since World War II.

Germany – German business confidence rose for the fifth month in a row in February, according to a closely watched survey.

The Ifo business climate index, which is based on a survey of 7,000 executives, edged higher to 109.8 in March, up from 109.6 in February.

Recent data on the German economy has been mixed. Last week, a report showed that German manufacturing activity contracted in March. Carsten Brzeski, an economist at ING Bank, said: “Today’s Ifo index illustrates once again the sound economic fundamentals. Even at a slower pace, the German economy should remain the eurozone growth showcase of this year.”

Commodities – Brent crude oil prices fell 1.1percent to USD123.53 on Thursday as it emerged leaders of developed economies are in talks to release emergency reserves to push fuel prices lower.

At the same time, Saudi Arabia’s oil minister said the country would do all it could to see lower oil prices.

The news shaved USD2 off the price of a barrel, which is up more than 15percent this quarter, and US oil stocks also closed weaker.

The U.S., U.K., France and Japan are mulling the release of billions of barrels of oil to the market in the hope lower fuel prices will boost economies.

Spotlight on: the importance of the price of oil

While the price of oil is rising, demand for the physical commodity is in retreat. Problems with Iran contribute to the story as a geopolitical risk premium is built into futures contracts, inflicting higher fuel costs on consumers.

The recently issued statement from HSBC that “oil is the new Greece” must have raised a smile or two in financial markets. Underneath, of course, lies a more serious concern.

With the European Union (EU) embargo on Iranian oil, the various other U.S. and E.U trade sanctions that are protests against Iran’s nuclear programme, along with Iran’s threat to close the Strait of Hormuz (through which 18percent of global oil passes), the price of oil has risen again in recent months.

The period from October 2011 to March this year witnessed a rise of about 20percent, with the price of Brent, the global benchmark for crude oil, hitting highs of about USD125 a barrel. Many wonder if the price will creep up again to the record high of USD147 in July 2008.

The surge in prices, which has generated debate in the financial media, comes at a fragile time for the world economy. Many feel that the associated rises in petrol and other costs are the dominant headwind to an economic recovery.

Given the situation with Iran, Nouriel Roubini, a prominent economist, recently warned that another spike in oil prices is the leading risk for the world economy. “You see a substantial geopolitical risk premium built into the oil price,” says Tim Evans, an energy analyst with the Citi Futures Perspective team of Citigroup, the American financial services firm.

“It has become a one-issue market. We are essentially seeing long-side bets based on expectations of a loss of Iranian oil supply.”

Evans says that a volatile mix of factors is in play. There is an appetite for risk, he says, but based around demand for a futures position, the buying of paper contracts, not the physical demand for petroleum. Real economic demand for oil, by contrast, is in retreat.

For the U.S., the world’s largest consumer of petroleum, total petroleum demand in the four weeks ending March 9 is down 5.4percent year-on-year. Gasoline demand is down 7.2percent for the same period. Production, however, is 4percent a year higher than a year ago.

More generally, the International Energy Agency (IEA) has forecast shrinking demand for oil from developed nations for 2012, and modest growth in the developing world of 2.8percent.

“We are seeing a bit of a bubble, understandably connected to the take on Iran and the embargo,” says Evans.

Imagine the unlikely scenario of Mahmoud Ahmadinejad, the Iranian president, suddenly being invited to the White House for talks, he suggests.

“That would probably spark downside chaos in the oil market.”

The last decade has set in motion a peculiar new direction that the industry is still trying to get to grips with. This involves not only developments specific to oil but also macro trends that have driven what has been called the largest commodities boom in history.

As is well known, China and other developing nations provide huge demand for commodities as part of their drive to industrialise, urbanise and develop economically. In the context of rising commodity prices set off by this, the financial sector in the western world in turn has sought to profit from this development by marketing commodities as a new asset class – a term some refer to as a “financialization” process.

Consumers in the countries where quantitative easing (QE) has been introduced, however, face higher petrol prices and inflation. More generally, it is not difficult to see why rising oil and therefore petrol, fuel and heating costs, and inflation in general, are causing concern.

With stagnant or declining real wages, and high unemployment in many parts of the developed world, living standards are already coming under pressure. Inflation adds to the cost of living and, of course, has a more serious impact on the poorest of the world in the developing nations.

A complicating factor is that oil prices seem to play a paradoxical role in the global economy. While a high price punishes consumers and other producers, it also incentivises new capital to invest in new exploration, technology and extraction.

On the positive side, perhaps, is China’s long-term role. Its demand for commodities is seeing it make a contribution in areas of the developing world such as Africa. It has the potential to become a major energy innovator in clean-tech.

Either way, with the global economy on a knife-edge, the future price of oil can be added to the seemingly ever-growing list of fundamentals that will determine the likely emergence from the recessionary conditions that many advanced economies currently find themselves in.

The information set out herein has been obtained from various public sources and is by way of information only. Broadgate Financial can accept no liability of any sort in relation thereto and readers should obtain their own verification of any statement before making any decision which may have any financial or other impact.

Neither the information nor the opinions herein constitute, or are they to be construed as, an offer or a solicitation of an offer to buy or sell investments.

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