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How The Fed Dictates Oil Prices

By CommoditiesJun 04, 2014 08:05AM GMT Add a Comment
 
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Think interest rates are going to head higher soon with the Federal Reserve’s bond tapering program?

Keep dreaming…

The Fed is still buying tens of billions of dollars in bonds, which will continue to drive down rates. And the money supply is still increasing – just at a slower pace.

So the 10-year U.S. Treasury bond – which is yielding just under 2.5% – is bound to head lower still.

Of course, the United States isn’t the only country seeing lower rates…

The bond yield in Germany and France is actually more than 100 basis points below the United States’ 2.5%.

And in Italy and Bulgaria, the bond yield is only 50 and 75 basis points higher than in the United States, respectively.

With lower rates around the globe, two immediate concerns should come to mind…

Concern #1: Sluggish Growth Ahead. Low yields are usually a signal of slow growth in the months and years ahead.

Indeed, the only major global economy that’s growing right now is the United States. And even our economy experienced a setback with the latest GDP numbers, which showed a decrease in GDP in the first quarter by 1% (after a 2.6% increase in the fourth quarter of 2013).

Now, the decrease can be attributed to a harsh winter that forced many to curtail spending. But in a strong, growing economy, negative GDP numbers should never occur.

However, uneven growth is still preferable to the rest of the world – where markets like China are showing signs of a real slowdown in spending and consumption.

Concern #2: Are Oil Prices in Trouble? Shrinking GDP numbers and decreasing yields from the bond market can signal danger ahead for oil price growth.

But is it time to sell your oil stocks? Heck, no!

Granted, at best, the oil market will stay static from here – or grow slightly.

At worst, we’ll see oil prices tick down into the $90s, as there’s no lack of supply in the market. U.S. oil production is nearing the same levels as the boom times of the ‘70s. And Middle Eastern oil facilities are pumping out as much oil as they can, since their concerns are related more towards making money for their oil-financed economies.

The picture for oil prices might not look as robust as it did just a few months ago – when the global geo-political situation was in flux and the United States was in the midst of a stronger recovery. But it’s definitely not time to sell!

Holding Out Hope for a “Goldilocks Recovery”

There’s a chance that we’ll see a “Goldilocks recovery” – or an economy that’s “just right.”

In that case, global economies will respond to the cheap money and continue to post growth (albeit nothing spectacular).

That would support oil prices in a range of $90 to $110 – levels high enough for all to continue to make money and pay out dividends

If you’re looking for true earnings growth from the energy complex, though, you need to be investing in integrated oil and gas companies.

These opportunities will continue to benefit from the resurgence of natural gas prices, which are the standout in the energy sector today.

In an upcoming issue, I’ll feature a couple of my favorite plays in the sector.

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