Crude oil gained more than 3% on the New York Mercantile Exchange Tuesday, following positive moves on the S&P.
Mirroring the stock market, crude oil was able to climb $2.44 in a single day of trading, settling at $69.19 a barrel on the NYMEX Tuesday.
"If you overlaid today's oil action with the S&P 500, they would fit pretty closely," said Bill O'Grady, the chief markets strategist at St. Louis-based Confluence Investment Management LLC, an investment advisory and management firm.
Tracking Wall Street
After a dismal day on the stock market yesterday that brought the price of oil lower, the equities markets recovered a bit today, bringing oil prices with them.
"Oil prices are basically following stocks because there is great uncertainty about the recovery, how strong it's going to be, whether we're in one or not, and the stock market is probably the best real-time indicator of how the economy is doing," O'Grady explained.
Economic optimism has been fueling a rise in oil prices recently, with investors basing buying on the hope that the recession is coming to a close and energy demand will increase.
"When we get economic reports that are friendly to the economy and support the idea of recovery, it tends to lift equity markets," he continued. "And oil plays along because there is a belief out there that once the world economy recovers that we will run into supply constraints very quickly in oil, and prices will go up very significantly. Anything that supports the growth story tends to support oil prices, and it's best expressed in the behavior of equity markets."
The Road to Economic Recovery
Although the official word about the recovery of the economy will come from the National Bureau of Economic Research, the organization usually issues it far later than the actual economic turnaround has occurred. Nonetheless, there are economic predictors that can help economist determine whether the recession has come to a close or not.
"Frankly, there's always a great deal of uncertainty about when a business cycle starts and stops," said O'Grady. "I've got different variables that I use to determine when we go into recession and when we go out, and the majority of the variables that I use suggest that the recession probably ended in June."
The end of the recession does not necessarily mark a dramatic recovery; right now, it just means that the economy is not getting worse. Then the business cycle will enter a recovery and eventually an expansion.
While O'Grady revealed that the majority of economists have come to the conclusion that the recession has ended, the new debate encompasses the characteristics of the upcoming economic recovery.
"Consensus generally breaks into two broad camps. There is the V-shaped camp and the L-shaped camp. The V-shaped camp believes that you are going to get a very robust recovery," he said. "The L-shaped recovery means that we've stopped getting worse, but we don't get significantly better, that the economy just very gradually recovers."
While a V-shaped recovery has history on its side, O'Grady leans towards the US having a slow L-shaped recovery.
"I don't think that it's going to be a V recovery because you have had about 15, maybe 20, years of excessive consumption," O'Grady said of spending in the United States. "Americans have been levering themselves through borrowing against their homes and against credit cards, supporting a level of consumption that they couldn't support without being able to tap credit."
"It doesn't mean we won't recover; it doesn't mean that people won't continue to spend money, but they'll spend it less recklessly than they used to, which, frankly, isn't a bad thing, it's just that it's going to hamper economic growth here," he added.
However, O'Grady doesn't believe the world will experience a gradual recovery, just the US.
"The rest of the world will probably grow pretty fast," he said. "We're already seeing pretty good growth coming out of Asia, and that's a much more important factor for oil prices, frankly, than what happens here. Although we are the world's largest consumer, most of the marginal demand is coming from the Far East."
Natural Gas Dips Lower
Further explaining the differences in recovery in the US and the rest of the world, O'Grady likened the situation to the relationship between oil prices and natural gas prices.
"It's really where you see the difference between natural gas and oil," O'Grady explained. "Natural gas is primarily a North American commodity, and it's going to be dependent on the shape of the recovery here to some extent. Whereas for oil, it's the shape of the global recovery, which will more than likely be stronger than what we get here."
Further representing this schism, natural gas continued falling on the NYMEX Tuesday, settling at a new low of $3.096.
"Natural gas is facing really two problems; the first is if the US recovery turns out to be a slow recovery, one of the factors that has been bearish for natural gas has been weak industrial activity. You'll see industrial activity improve, but it's going to improve very slowly," O'Grady stated. "The second problem is you are rapidly coming to the end of summer and you're heading into one of the shoulder months for demand. Barring some kind of hurricane disruption, there's really nothing on the horizon that's going to tighten the supply and demand balance."
A massive over supply of natural gas and ever-weakening demand have helped to push the price of the commodity to this year's low. With the summer cooling season ending and the winter heating season a ways away, demand for natural gas is further dampened.
"I'm guessing we're probably going to have natural gas prices depressed through the first quarter of next year, unless we get a wooly-mammoth-down-Wall-Street-type winter," O'Grady concluded.
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