INSIGHTS

On April 30, 2012

The Disconnect between the Oil Market and China’s GDP

Charting any security has become a complex mixture of science and art over the years.  Perhaps charting is more closely followed in the commodity markets with currency and equities following closely behind.

Fundamentally, we have shown some disconnects in the oil market’s price with that of one of the largest contributors to its rise – the growth rate in China.  Last week, China reported a growth rate of 8.1%, which would be the envy of nearly every other country except for the fact that China has averaged  9.50% for the past 20 years.  What has brought about some curiosity, is the stability in oil and the disconnect with China’s GDP.

Following the broad arrows shows some decent correlation; however, the recovery in oil has not coincided with the recent drop in the gains of the Chinese economy.  Whenever we see large disconnects such as this, some reversion looks to be expected.  As evidenced by the following chart, it looks like it might be coming sooner rather than later, according to the Bloomberg chart below.

What we see representing the green and red lines is traditionally called a “flag” or “pennant” pattern.  The expectation is that as the band narrows toward the end of the pennant, often a breakout or breakdown is seen.  As to which way it breaks, one must look at a large number of criteria and often seem only rational after the fact. 

What we tend to see forces that seem to point to a slight break down versus breaking up. 

Reasons why it might break down:

• Already seeing the flare up of the European crisis start to drag on economic growth expectations.
• China’s GDP is running below average at its current rate
• The U.S. Stealth recovery is still continuing to gain traction, though not at levels that oil bulls may feel will support global growth in lieu of Europe and China’s tepid (subjective with regards to China) growth.
• Drop in demand for gasoline on an aggregate domestic scale as gasoline consumption dropped by 3% through the first quarter of 2012 from the same time in 2011, according to the MasterCard spending reviews.  The increase in the average miles per gallon from car manufacturers just exceeded 24, which is an increase of 20% from just four years ago.
• There is also the estimated increase in the U.S. production of oil that now is estimated to increase by 500,000 barrels a day by 2020.

Perhaps the one aspect that has been keeping oil from declining is the age old issue of political stability in the Middle East as well as disruptive supply expectations.

It appears the crystal ball for the immediate outlook for oil can be a bit “crude,” but in joining the recent price patterns and the preponderance of potential short-term negative news for oil, a drop might be expected over the summer. 

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