Remember early last year when oil prices ‘went negative’?
Well, despite scary headlines, the actual prices themselves didn’t go negative, but there certainly was a major drop in the value of oil. Markets often get the direction of the economy right, but they also can go too far.
So when prices are rising into bubble territory, it can signal growth, but sometimes they can go too far. And the contrary can happen during panics. Oil prices were right in signaling a downturn, but, in light of subsequent events, they arguably went too far down.
As you can see below, oil prices can be quite volatile and there are certainly times when crashes anticipated recessions, such as 1990, 2008, 2013, and 2020.
Just as we did with copper, another industrial commodity, we made some adjustments to account for changes in oil prices to account for inflation, deflation, and supply disruptions. Accounting for supply disruptions is probably more important for oil than for copper because oil comes out of some of the most unstable countries in the world. Someone in a rubber boat can throw a hand grenade at a boat in the Straits of Hormuz and it could potentially move oil prices. Middle eastern wars are, unfortunately, not rare, and they can definitely move markets.
When we’ve adjusted for inflation and supply and put this adjusted oil price on a graph along with the following year’s growth, we see that something appears to be going on:
There is a cluster in the lower left and in the upper right, which is pretty much what a positive correlation means. The upward-sloping line simply shows that relationship based on a single equation. But the fit is clearly not as good as, say, the copper chart we showed in a previous report.
So, why pay attention if the fit is not as reliable as other factors like copper prices? First, because in a multitude of counselors there is safety. Second, because the past year has not been about the middle east, which has, at least by historical standards, been relatively calm. Oil didn’t collapse last April because someone suddenly discovered a massive new well. It fell because buyers bet that the world would shut down, and although it didn’t shut down entirely, something definitely happened. And it didn’t rise because a hurricane hit New Orleans or a bomb hit Saudi Arabia. It rose because the economic contraction was short-lived and reversed quickly. If there had been some shift in the geopolitics affecting oil markets, we would tend to be less interested in the oil price signal.
So, once again, markets got the direction right, but went too far. Not an unusual story. The oil story is that the world will probably grow this year, but the oil story is not as optimistic as the copper story.
Originally published on Townhall Finance.
Jerry Bowyer is a Forbes contributor, contributing editor of AffluentInvestor.com, and Senior Fellow in Business Economics at The Center for Cultural Leadership.
Jerry has compiled an impressive record as a leading thinker in finance and economics. He worked as an auditor and a tax consultant with Arthur Anderson, as Vice President of the Beechwood Company which is the family office associated with Federated Investors, and has consulted in various privatization efforts for Allegheny County, Pennsylvania. He founded the influential economic think tank, the Allegheny Institute, and has lectured extensively at universities, businesses and civic groups.
Jerry has been a member of three investment committees, among which is Benchmark Financial, Pittsburgh’s largest financial services firm. Jerry had been a regular commentator on Fox Business News and Fox News. He was formerly a CNBC Contributor, has guest-hosted “The Kudlow Report”, and has written for CNBC.com, National Review Online, and The Wall Street Journal, as well as many other publications. He is the author of The Bush Boom and more recently The Free Market Capitalist’s Survival Guide, published by HarperCollins. Jerry is the President of Bowyer Research.
Jerry consulted extensively with the Bush White House on matters pertaining to the recent economic crisis. He has been quoted in the New York Times, The Wall Street Journal, Forbes Magazine, The International Herald Tribune and various local newspapers. He has been a contributing editor of National Review Online, The New York Sun and Townhall Magazine. Jerry has hosted daily radio and TV programs and was one of the founding members of WQED’s On-Q Friday Roundtable. He has guest-hosted the Bill Bennett radio program as well as radio programs in Chicago, Dallas and Los Angeles.
Jerry is the former host of WorldView, a nationally syndicated Sunday-morning political talk show created on the model of Meet The Press. On WorldView, Jerry interviewed distinguished guests including the Vice President, Treasury Secretary, HUD Secretary, former Secretary of Sate Condoleezza Rice, former Presidential Advisor Carl Rove, former Attorney General Edwin Meese and publisher Steve Forbes.
Jerry has taught social ethics at Ottawa Theological Hall, public policy at Saint Vincent’s College, and guest lectured at Carnegie Mellon’s graduate Heinz School of Public Policy. In 1997 Jerry gave the commencement address at his alma mater, Robert Morris University. He was the youngest speaker in the history of the school, and the school received more requests for transcripts of Jerry’s speech than at any other time in its 120-year history.
Jerry lives in Pennsylvania with his wife, Susan, and the youngest three of their seven children.
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