Oil, inflation, the dollar and stock markets

Headline (Globe & Mail) JULY 2005

The headline you see here is from 2005.  It appeared at the height of the last frenzy in energy markets, and  I fear we are at that stage again.  Here is a headline (Bloomberg) from today:

“Oil increased for the fourth time in five days as speculation that the European Central Bank will further raise interest rates strengthened the euro against the dollar, boosting commodities’ appeal as an alternate investment.” 

 It begs the question, as an ‘alternate’ to what?  Commodities and gold, real estate are all considered to be hedges against the onslaught of inflation but it really isn’t that simple.  Upward pricing pressure occurs for complex economic reasons.  For example, I wrote this for my newly released book almost a year ago, but I was talking about what was happening back in 2005-ish.

“After all, economic theory and common sense dictate that if the price of oil rises so much that other industries dependent on oil can’t make profits, and consumers must cut back their buying because they’ve spent all their discretionary cash on fuel, then economic growth must falter.  Demand for oil then reverses and ultimately so does the price.  The onset of global recession obliterated all the gains made in energy sector stocks much faster than they were earned.”

It should not be surprising then that virutally every sector senstive to oil prices would have to increase pricing in order to keep profit margins from eroding.  Today though, there is a slowdown in global industrial production 1) due to cost pressures and 2) do to the disruption of economic activity due to Japan.  The latter has only begun to be felt – Toyota shutting down auto plants around the world is a dead giveaway.  The ECB might lift interest rates, but it really isn’t necessary – the effect of oil prices and Japan will cause the required dampening.  The US dollar is taking a short term licking, but the weak dollar is the best thing for the US economy.  Sectors ‘in’ global demand with pricing power will continue to help the US trade deficit.  I’ve argued that the breadth of the stock market will improve, and that it is sectors being ignored currently that offer the most promise.  A case in point:

“Stocks rose the most in a month and U.S. index futures gained as Intel Corp. (INTC) forecast higher sales and company results in Europe and Asia beat estimates.”

The message? Don’t get lured back into early cycle plays like commodities (oil, copper, gold) because the really big returns are to be had elsewhere.  I do expect (see previous commentary) a correction of sorts will be necessary soon, but the best defense is a good offense (finally applied last night by the Chicago Blackhawks).

Invest to Live; Live to Ride

About Mal Spooner

Malvin Spooner is a veteran money manager, former CEO of award-winning investment fund management boutique he founded. He recently authored A Maverick Investor's Guidebook which blends his experience touring across the heartland in the United States with valuable investing tips and stories. He has been quoted and published for many years in business journals, newspapers and has been featured on many television programs over his career. An avid motorcycle enthusiast, and known across Canada as a part-time musician performing rock ‘n’ roll for charity, Mal is known for his candour and non-traditional (‘maverick’) thinking when discussing financial markets. His previous book published by Insomniac Press — Resources Rock: How to Invest in the Next Global Boom in Natural Resources which he authored with Pamela Clark — predicted the resources boom back in early 2004.
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One Response to Oil, inflation, the dollar and stock markets

  1. Aminul Haque says:

    It seems even you subscribe to the idea that commodities, especially oil is an “alternative investment”, to give protection against inflation. In other words, the rise in commodity prices is a result of buying purely for financial reasons. Has that been proven? Then why is the case that while other inflation hedges such as real estate are languishing whereas commodities bounced back a short while after the global financial crisis? In a world of slowing supply and limited spare capacity, any number of things can spike commodity and keep it permanently there, including inflation, geopolitical events and currency movements. Secondly, why do you think that the US$ weakness is “short term”? Are the twin effects of a huge deficit and excess supply of money going away shortly? Other than these two points, I fully agree that there would be a broader-based US rally, especially in manufacturing and service supported by a weak US$.

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