2011/03/08

Copper/Oil Spread Blowout

Via Paul Krugman, prices of copper and oil have started to diverge sharply.  Paul provides his usual accurate and succinct analysis.  Way back in 2008, when a number of commodity prices were still scraping along the bottom, copper was one of the first to rally.  As an extremely important industrial raw material, copper therefore makes for a pretty good indicator of market expectations for the real economy's performance (although stockpiling always exists, as the Chinese pig farmers made clear a couple of years ago).

Oil should be a good indicator for the direction of the real economy and should, arguably, move in tandem with copper (as they have done up until very recently).  Although Professor Krugman would disagree with me, as he has done publicly with Yves Smith, I believe that speculation and potential market manipulation play to large a role in oil markets to make it a truly accurate indicator.  All that aside, oil reflects one other thing that copper does not: geopolitical instability.  With supplies highly concentrated in some of the world's more volatile regions, oil is always subject to large price swings brought on by any Middle Eastern dustups.

Nevertheless, the movement in this price relationship seems like something to watch closely.  Instability and high oil prices will start to drag on the global recovery pretty quickly.  Some research shows that a permanent, or at least semipermanent, $10 increase in the price of oil shaves 0.2% off of GDP.  Not huge, but not totally insignificant either.  For the time being, the disruptions in the oil market have been fairly minor.  Libya was producing about 1.6 million barrels of oil a day before the uprising against batshit crazy dictator Muammar Qaddafi.  In fact, all of the uprisings in the Middle East so far have been in relatively minor oil producing states with the exception of Qatar, where the crackdown on dissent seems to be having more success.

I'm hardly the first to speculate on it, but the real concern if you're worried about the global economy is that this unrest may spread to Saudi Arabia, which has for now been pumping more to make up for Libya's lost output.  It isn't hard to imagine prices well in excess of the 2008 peak if Saudi's long-suffering Shia minority gets the same idea as the folks in Tunisia, Egypt and Libya.

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