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"Always analyze a security in conjunction with others in its relative market."
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Wednesday, 06 February 2008 |
An Ironic twist to the relationship of oil futures and interest rate cuts
Normally, we would think that as interest rates fall, commodity prices rise. This is true. But what we forget to add into future price equations is consumer demand.
Economic Slowdowns Hurt Demand
As the Fed cuts and continues to cut rates, the Dollar Index will continue o decrease. The bullishness of treasury notes is symbolic for less risky investments - or, most commodities that had intrinsic value will rise. Some commodities like Lumber will slump in this state because of a number of reasons: less home building, rising Gold prices, etc. But as for Crude Oil futures, they will rise, initially.
What this Means for Gas Prices
If you examine some fuel equities, you will notice that most have increased in value after Crude Oil prices peaked in December of 2007. In prolonged states of economic shock, this is usually the case. Not because oil companies make more profit from higher oil prices, but from bullishness of future profit outlook (remember, this is for prolonged periods or two or more quarters).
This is where the ironic twist to normal derivative knowledge occurs: usually we expect gas prices to remain high when oil prices are high from monetary volatility like the declining value of the dollar. However, what about the other side of the market - consumer demand?
As the value of the dollar declines, consumers allocate their resources more conservatively. In other words, gasoline usage will be cut to a necessity based use. Oil companies will eventually see the slow down and purchase Crude Oil puts to remain ahead of the game by purchasing oil at a cheaper price than what it is marked.
Notice how the Crude Oil price has declined, but Oil equity prices have risen.
Conclusion
If gas prices fall will this mean we will get gas cheaper? Relatively Speaking, it depends on the value of the dollar. But to put this all together, perhaps we can assess future oil prices by using oil equities in prolonged economic trends.
This chart shows oil prices back in 2001. Notice the decline in price towards the end of the year.
Comparing the end of 2001 with Crude Oil prices, observe the end of 2001 gas prices. Notice the bullish trend.
If oil equities are bullish, maybe the smart money is moving in before the herd comes. The Smart Investors know that in the future, gas prices will decline, more consumers will purchase gas, and so to will profits increase.
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