The current oil market is providing us with the latest example of why figures need to be read carefully – especially when it comes to using a single number as a crystal ball with which to provide a prophecy on where oil prices are heading.
On Friday, the U.S. economy posted a dismal rise of only 20,000 new jobs in February, some 160,000 below estimates. Shortly after, West Texas Intermediate (WTI) – the oil benchmark set daily in New York – sank 3%.
Crude oil prices recovered as the day progressed. Nonetheless, at close of trade (2:30 PM for oil), WTI was still down 1.2% for the day. Yesterday, it rebounded and is continuing to move up as I write this on Tuesday morning.
Friday’s figure left market observers scratching their heads.
Those watchers I have talked to over the past several days consider it an outlier, following what has been a better than average employment picture over the past several reports. Yet as it stands, it’s certainly the worst monthly performance in recent memory.
Of course, as happens often, that figure is likely to be revised over the next two months.
But the dismal report still had a major (although, it seems, fleeting) impact on oil traders. And that occasions a simple question:
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Anecdotally, a decline in economic prospects is perceived as a developing weakness in oil demand. That, according to this argument, translates into a downward pressure on prices.
Economic prospects remain a main yardstick in gauging market strength. That strength, in turn, becomes a barometer for opinions about how much oil is needed. However, nothing in this calculation provides an immediate rationale for pushing down crude prices. Rather, everything requires a quarter or longer to establish a trend.
My point here is simple.
There is no factor that singularly determines anything about oil prices merely because it is recorded. If employment, for example, is indicative all by itself that oil prices should decline, then such a causal element needs to have a direct economic impact.
Yet there is no individual indicator that has that power.
Here, it is important to note the difference between leading and lagging indicators.
Time Is of the Essence in This Market
Leading indicators often change prior to large economic adjustments, and are regarded as predictive of future trends.
These indicators include stock market performance, manufacturing activity, inventory levels, retail sales, building permits, the housing market, and new business startups.
Meanwhile, lagging indicators reflect how the economy has performed over time. However, these emerge only after an economic trend or pattern has already been established.
Such indicators include changes in the gross domestic product (GDP), levels of income and wages, the unemployment rate, inflation, the strength of the dollar (or any currency) in foreign exchange and purchasing power, interest rates, corporate profits, balance of trade, and the attractiveness of commodities substituted for the dollar (i.e., gold, silver, etc.).
This last indicator reflects a major function of currency, to serve as a “value holder” for all manner of things in an economy.
Well, here’s the kicker with all of these.
Not one of them is revealed in less than three months, and most of the more important require at least a six-month trend. The emergence of new jobs, while a part of the mix, is not even singled out by economists as a standalone.
All of the leading indicators taken together and moving in the same direction may, after at least a quarter has expired, convey a picture of what the underlying economy is doing. But notice employment does not drive anything independently, especially when it comes to trying to figure out how much oil is in demand.
Okay, then the reaction to an abysmal new jobs figure was a knee-jerk response, overhyping the fear that oil prices could be retreating (at some more distant point in the future?).
Still there is the question, are there other signals of broader moves telegraphing that such a retreat may be coming?
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Multiple Factors in Place in Oil Demand
Once again, that depends how you read them. And once again, one month’s number does not a trend make.
For example, the European Central Bank on Thursday – the day before the U.S. jobs data were released – cut its latest growth estimate for the continent to 1.1%, down from 1.7%. The ECB, through its President Mario Draghi, pointed to “a period of continued weakness and pervasive uncertainty.”
Brexit – the UK muddled move to break from the EU – certainly has something to do with the uncertainty. But neither Europe nor the U.S. dictate global oil demand.
As I have observed on several occasions in Oil & Energy Investor, the driver is Asia.
Which brings us to one of the other main matters viewed by pundits looking for a quick read on where oil prices are heading.
And that is China.
The Chinese Factor
Here, there are again concerns that the Chinese economy is slowing down.
As proof, some have pointed to the remarkable decline in Chinese exports and imports in February. According to some, this is a clear indicator that the Chinese market is cooling off, and having a negative impact on Asian oil demand.
This may be something worth looking at seriously if not for one other matter.
For the same month of February, Chinese oil imports surged to over 10.2 million barrels a day.
That’s the third highest monthly figure on record.
U.S. jobs data hardly show a retrenchment in what remains essentially a full employment economy; we have a low unemployment rate and little tangible indications of inflation anywhere on the horizon.
Elsewhere, China is importing more oil, and both the International Energy Agency (IEA) and OPEC are reporting that global oil demand in 2019 will continue to rise.
Simply put, the wider picture seems to be the reason why a bad U.S. jobs report has no staying power when it comes to where oil prices are moving.
There are, however, other factors, which I have discussed previously here in Oil & Energy Investor, and I plan on discussing further in future columns.
In addition, I’m looking forward to attending the annual Black Diamond Conference in Delray Beach, Florida in a few weeks, where I’ll be discussing several matters pertaining to oil and energy.
If you’d like to register to attend, just click here.
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