Despite a rally earlier in the day that brought the price of oil above $60, crude oil remained steady in trading on the New York Mercantile Exchange Tuesday, closing below $60 for the third day in a row. Despite stronger economic data encouraging investments early on, crude oil prices could not keep up the rally.
In trading Tuesday, crude oil settled on the NYMEX at $59.51, a drop of another 18 cents from the close Monday. The recent decrease in oil prices represents a more than 10% drop for the energy commodity.
With positive news coming out early about the economy, the price of oil rallied above $60 for the majority of the day. Goldman Sachs reported record earnings, and retail sales in the US rose .06%.
"Today you're just squaring up in front of the report," said Bill O'Grady, the chief markets strategist at St. Louis-based Confluence Investment Management LLC, an investment advisory and management firm. "You still have oil trading with equities. So when equity markets do better, oil tends to do a little bit better."
Despite a renewed optimism in the state of the economy with this news, it was not enough to keep the price above $60 by the end of the day. With weak fundamentals tainting investments in crude oil, the price per barrel has continued to drop.
"Now, the consumption fundamentals for energy remain pretty dismal," O'Grady continued. "You've still got very significant inventory overhangs in the crude oil and distillate fuels. Gasoline demand remains pretty lackluster. You got a little bit of help for natural gas a couple of weeks ago when the weather got hot, but the temperatures weren't maintained outside of Texas. It cooled off; demand fell; and natural gas prices retreated."
Inflation Equals Higher Oil Prices
Despite the recent drop in oil prices, the analyst believes that the price of oil will most likely rise again, on the heels of an inflationary threat.
"The fear out there is that if the economy starts to grow that there is so much liquidity pumped into the system that you'll end up having a significant inflation problem," explained O'Grady. "This is frankly a side effect of a huge debate going on in the economics community, as to whether or not the stimulus will end up being inflationary or not.
The threat of inflation causes more investments in hard assets such as crude oil.
"If it is inflationary, there's a big investment demand for commodities, and crude oil benefits from that," O'Grady continued. "As you get economic reports that tend to support the economy, then you that helps equities; that rise in equities then raises concerns that 'Oh my gosh, we're going to start growing too fast,' and then people start buying commodities to protect their portfolios. And you get oil prices to go up."
While fundamentals remain weak, the commodity markets will be boosted by this fear of inflation, which is magnified by any improvements in the economy.
"Ultimately, I think we're in a cycle right now where oil prices are going to be directly driven by expectations about future economic growth," O'Grady said. "If we start to see better economic numbers -- and I think we will. If anything I think the recession may be close to over. If that's what we start to see, then as the economy picks up, you'll see oil prices lift."
Highs & Lows
After a rollercoaster ride on the commodities market, crude oil has some pretty big limits, according to O'Grady. There is a price that is too high for the market to bear, and a price too low for the industry to produce.
"Now, you'll eventually reach an oil price that is 'too high,' and that will tend to become a negative for the economy, but I think we're quite a ways from that," O'Grady said.
The market may have already hit that high -- before its recent tumble to correct itself.
"How far they get above $70 to $75, it's problematic," he continued. "You've got too much excess capacity within OPEC, and the world economic recovery is still going to be pretty slow. I don't think we're looking to go back to the $150 level, probably at least for the next 12 months."
Future volatility in the price of oil is expected, riding the economic news rather than fundamentals.
"Traditionally, when you have a recession this deep, it's not uncommon for the recovery to be initially really strong and then peter out," O'Grady explained. "I think that's what we're going to see; about 18 months from now, we'll be facing another recession. I think you're looking at price volatility."
On the other hand, there is a low, although this analyst doesn't see a high probability of reaching the bottom.
"Fundamentally, if you don't have investment demand supporting the price of oil, high $30s is not out of the question; but that's assuming we just don't get any recovery at all, and the fear of inflation dissipates," O'Grady concluded.
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