Rational Advisor

Another topsy-turvy week ended with a fizzle

The indexes fell as concerns mounted about a slowing global economy and the effect on oil and metal stocks.

You have the whole strengthening (U.S.) currency which takes money away from commodities and you’ve got demand destruction because of the slowdown in the overall economies. This correction in commodity prices is decreasing inflation risks, which takes the interest rate risks away for investors and gives the economies and the financial system more time to recover and ultimately a stronger rebound in the economy when it comes rather than short circuiting it with inflation fears and rate hikes. That risk being reduced is significant.

The main direction of oil has been down since hitting a record of just over US $147 on July 11 on the belief that economies around the world are slowing down, if not in recession. Last week, both Germany and France reported declines in second-quarter gross domestic product, their first quarterly decreases in years.

Energy and materials stocks still account for 47 per cent of the value of the broad Canadian index, down from about 54 per cent a month ago. So, when the price of natural resources falls, the Toronto index has a hard time gaining.

Russia’s Alpha Bank said in a report last week that crude oil could fall below $100 within weeks and not reach the $200 price level that some have predicted for another five or 10 years. But some forecasters still expect a return to the $145 level later this year.

The high price of oil still affects things. Prices are still high enough to hurt economic growth, and thus corporate profits, over the next several months. That could affect other sectors of the market.

Also, while the price of oil expressed in U.S. dollars has been falling, the US dollar has risen 5 to 10 per cent relative to other currencies, including Canada’s. So the savings will not seem quite so great outside of the United States. This is why even though the price of Oil has come down, we have not seen a similar drop at the pumps.

An OPEC forecast of lower demand also put downward pressure on prices.

In its monthly oil report, the organization forecast world appetite for oil this year overall will fall by 30,000 barrels a day. While forecasting demand growing by a daily one million barrels a day this year, and another 900,000 barrels in 2009, the report noted that world demand growth next year will also be “the lowest since 2002,” with demand growth from the major industrialized countries actually declining.

They’re basically saying we could have an oil glut because demand is slowing. It’s obvious that high prices do slow down demand and the market works.

The OPEC report came two days after the U.S. Department of Energy highlighted the ongoing drop in U.S. demand for energy as Americans struggle with high costs for gasoline, food and other goods.

Oil’s steady decline has continued despite the simmering weeklong conflict between Russia and Georgia over two breakaway provinces.

Russia’s invasion of Georgia may have reasserted its military might, but its stock market is anything but strong. Russian stocks are now down 30% from their highs.

Only weeks ago, the conflict in Georgia would likely have sent oil prices soaring. But the market has largely ignored the fighting because traders have already priced in the geopolitical risk, analysts say. Crude’s month-long nose dive has also made it harder for bullish traders to spark a rally, despite a possible threat to oil installations.

There’s no guarantee this decline will continue, since oil’s price is driven by such a complex mix of factors — including shadowy, but massive flows of speculative money.

There are many economists who have long believed that prices well above US $100 a barrel were far higher than could be sustained by global supply and demand. It seems they had a point.

Forecasters at the National Bank of Canada expect oil to head toward equilibrium somewhere between US $75 and US $80 a barrel over the coming year, a level that should be sustainable over the long run, says assistant chief economist Stefane Marion.

A new forecast published this week by the Economist Intelligence Unit predicts that oil will fall as low as US $85 late next year, averaging US $91 in 2009.

At the Toronto-Dominion Bank, a June forecast was that oil ought to settle near US $100 next year.

It’s true that demand is still rising in fast-growing economies like those of China and India. But fuel subsidies that shielded consumers and businesses in those countries from the true cost of their behaviour have become so costly that they are being phased out. It’s not unreasonable to believe that these countries might respond over the coming months by tapering off their growth in oil consumption.

If this happens, it’s possible that oil will, indeed, drop below US$ 100 and stay there, at least for a while. This would be good for the global economy in some important ways.

First, it would reverse the drag on global economic growth brought by skyrocketing cost of oil.

That would be particularly welcome in the U.S., where consumers are already shell-shocked by a meltdown in housing prices and a rise in unemployment. And any relief of economic pressure in the U.S. can only help the manufacturers of Ontario and Quebec, now suffering from the slump in their key market.

Second, lower oil prices would reduce the inflationary pressure that’s preventing central banks from stimulating growth in slowing economies all over the industrialized world. If oil starts dampening inflation instead of fuelling it, interest rates can come down as much as necessary.

Gold bullion moved below the US $800 level. The December gold contract on the Nymex closed down $22.40 to US$792.10

The dramatic sell-off - gold has slashed more than $100 off its prices since Aug. 1 - There are a bunch of bearish factors that have dented the metal’s safe-haven appeal: The once-limping U.S. dollar is strengthening against its rivals, crude oil is easing from record levels and signs suggest the worst may be over for the flagging U.S. economy.

Where could gold end up, we’ll probably see close to $680 at some near point.

According to Canada Mortgage and Housing Corp, Housing starts are forecast to decline in both this year and next as high prices crimp demand.

Bob Dugan, the chief economist for CMHC said “Starts this year are expected to ease in seven of 10 provinces, with only Saskatchewan, Ontario and Newfound and Labrador forecast to see starts rise.”

The situation will change in 2009, however, with Manitoba expected to be the only province to see higher housing starts.

Canadian average home prices have fallen for the second month in a row, raising concern by economists that the housing market may have been caught in the undertow of a U.S.-based slowdown.

Average home prices nationally fell by a significant 3.6 per cent to $327,020, from year ago levels in July, according to figures released by the Canadian Real Estate Association yesterday. In June, prices fell by 0.4 per cent, the first time the market recorded a decrease in nearly a decade.

The bulk of the declines were in the western provinces, with cities such as Calgary down by 7.8 per cent and Edmonton by 5.3 per cent. Vancouver market saw a 1 per cent drop, all helping to bring the national average down.

A drop in prices is typically preceded by a fall in sales. In this case, sales volumes in cities such as Vancouver were down by a 44 per cent, and Calgary by 13 per cent.

Sales are also down in the Toronto market, by 12 per cent, for the seventh month in a row. But prices are narrowly hanging on in positive territory, up by 1.5 per cent in July, over the same time last year.

But there’s no guarantee that will last. The provincial economy isn’t exactly holding up too well, so we certainly can’t rule out a future price decrease in the Toronto market It’s not improbable since the trajectory is downward and the market is definitely past its prime.

So far, no one is saying the Canadian market is going the way of the U.S. market, where a credit crunch has seen median home prices year over year fall by 14 per cent, and where some hard-hit areas have seen values drop by 50 per cent.

So what’s an investor to do right now?

Investors should look at whether they are overweight in commodities, downsize over-performing sectors and have some cash, be defensive still because the correction in commodities is still ongoing.

Review whether their mutual funds and other investments have too much exposure to Energy and Gold, emerging markets such as China and India.

Interest rates seem to have the ability to come lower, this means having Bonds in the portfolio could be a good idea. Especially in Canadian oriented investments.

Comments RSS