Market Mayhem

Most of us won’t have noticed much market mayhem going on in our daily lives, distracted by terrorism in the heart of Europe. An instantaneous jump of 30% in the value of the Swiss Franc last week means very little to most people. If only we had stashed a few Swiss Francs in advance.

Most readers of this blog should be aware that the price of oil has more than halved in the last 6 months rendering much of the global oil industry unprofitable which is an unprecedented disaster for all of those dependent upon oil in their daily lives. But what is the underlying cause of all this market mayhem and does it really matter?  The S&P 500 is after all riding high and the US$ keeps marching towards new highs against the € and other currencies. This post takes a look at a number of indicators searching for answers which are elusive.

Figure 1 The copper price has been on the skids since 2011, recently breaking through the $3 support. This is a sign of chronic weakness in the global economy, probably linked to China (Figure 2). Chart from the FT.

Figure 2 While China still has GDP growth over 7%, an enviable value, GDP growth rate has been slowing and has halved since 2007. The rate of growth for raw materials and imported luxury goods is presumably slowing and I dare say is part of the story behind weak copper and weakening Euro zone economies. When the World’s second largest economy catches a cold, its possible the rest of the world gets influenza. 2014 is estimated.

Figure 3 The economic performance of these four Mediterranean countries since the 2008 crash is, in short, shocking. Largely down to strain of being in the € zone. The 2014 data are not yet in, but currency and political woes seem to be continuing unabated, especially in Greece. 

Figure 4 The economic malaise of the € zone is reflected by the $/€ exchange with the € setting record lows in recent weeks. This chart has much in common with the copper price (Figure 1). Chart from the FT.

I’m sure many other countries are suffering from similar economic malaise that seems to have no end. These OECD nations are already joined by Russia and will shortly be joined by the majority of OPEC countries.

I want to move on now to the oil price (Figure 5) and in particular the WTI – Brent Spread (Figure 6).

Figure 5 The oil price crash is not unprecedented. In 2008 – 2009 it was associated with the biggest recession the world has known since 1929.

Figure 6 The chart shows the daily price for WTI less the price for Brent. WTI traditionally traded at a small premium to Brent. At around the year 2000 the small positive premium got a bit bigger and more volatile and then during the latter stages of the great oil bull run it became very volatile and turned negative. Post 2008 crash the wild oscillations continued until January 2011 when the spread turned sharply negative reaching $30 at one point. But now, as quickly as the yawning gap opened it has closed again. I’d quite like to know why the markets sustained such a large spread in the first place and why it has just closed.

One version of events is a glut of oil in Cushing Oklahoma caused in part by rising Canadian oil sands production and LTO production in the USA combined with a pipeline being run in reverse direction. Depressed prices in the mid-West was good news for refiners. For some reason, I’ve never fully bought into this story line.

An alternative or complimentary theory has been ventured by Chris Cook and that is Saudi Arabia has utilised QE dollars to manipulate the price of Brent. I’m not sure I buy into that story either but would not discount the possibility that the WTI-Brent spread is the result of market manipulation. There certainly seems to be a correspondence between the end of QE in the USA and the subsequent crash in the oil price (Figure 7).

Figure 7 The chart is from Chris Cook (former compliance and market supervision director of the International Petroleum Exchange). Chris Cook says this: “This simple chart shows how the US Fed Quantitative Easing (QE) and Twist programmes of dollar creation are almost perfectly correlated to the US WTI crude oil benchmark price: itself linked to the Brent/BFOE benchmark oil price.”

I’m afraid I disagree with the detail of this commentary but can agree with the general point. QE-1 probably saved the banks in 2009 and the world economy with it. But has the ending of QE3 undone all the balance sheet repair work of the past 6 years? I think we need to consider the possibility that the coincidence of the oil price crash and ending of QE3 is just that, a coincidence. Unless of course the Saudis really were manipulating the market.

Chris Cook had an Oil Drum post in January 2012 that is still worth reading:

Naked Oil

From 1995 to 2007 BP and Goldman Sachs were joined at the head, having the same chairman – the Irish former head of the World Trade Organisation, Peter Sutherland. From 1999 until he fell from grace in 2007 through revelations about his private life, BP’s CEO Lord Browne was also on the Goldman Sachs board.

And more recently on European Tribune:

Oil Market: A Picture Tells A Thousand Words

Fed Chairman janet Yellen

Finally, not a chart but a picture of someone who we must hope is incredibly smart and who appears to not lack courage. Janet Yellen, chairman of The Fed, is responsible for ending QE and signalling the end of government intervention in markets. My friend Ilargi at The Automatic Earth had this to say:

The End Of Fed QE Didn’t Start Market Madness, It Ended It

What we see now is the recovery of price discovery, and therefore the functioning economy, and it shouldn’t be a big surprise that it doesn’t come in a smooth transition. Six years is a long time. Moreover, it was never just QE that distorted the markets, there was – and is – the ultra-low interest rate policy developed nations’ central banks adhere to like it was the gospel, and there’s always been the narrative of economic recovery just around the corner that the politico/media system incessantly drowned the world in.

That the QE madness ended with the decapitation of the price of oil seems only fitting. Our economies need oil the way people – and animals – need water. If its price falls the way it has, that’s a sure sign something is profoundly amiss. At this point, we don’t yet know the half of it. It’ll take time for price discovery to work its way through, and for people to recognize what things are really worth. For now there’s really only one that’s certain: everything is overvalued, including you.

And so to try and conclude. This from Oil Production Vital Statistics – January 2015:

The plunge continues at a similar speed to the 2008 crash. The 2008 oil price crash began in early July. It was not until 16th September, about 10 weeks later, that the markets crashed. 

Few if any of the core issues that lay at the heart of economic woes in 2008 have been fixed. Too high borrowing continues, too high debts, zero interest rates, the spectre of deflation, bankers bonuses, low pay growth for the masses, OECD unemployment, corruption, the unstable € zone, recession in many OECD countries and now slowing growth in China. It is difficult to pick a date for the beginning of market mayhem but the end of October, when The Fed ended QE3 is as good a date as any. 10 weeks is already up.

If the world discovers that $50 is the right price for oil it is also going to discover that several million barrels per day production will be wiped out and that the world economy will have to shrink to accommodate the narrower energy base. This may be strongly deflationary. It will also cause extreme distress in Russia, Iran, Iraq, Algeria, Nigeria and Venezuela. However, I will stand by my earlier analysis of Oil Price Scenarios for 2015 and 2016 and anticipate that the oil price recovers strongly next year. Companies and countries will have to hang tough this year.

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34 Responses to Market Mayhem

  1. Javier says:


    My two cents are that the end of QE has brought about the end of easy money to move to emerging markets to invest in growth and receive higher interests. Money is now pricing higher interests in the USA and therefore is reversing carry trade, coming out of emerging markets causing reduction of growth there and a fall in commodities prices, and coming out of Europe. So the dollar rises and the rest fall. Swiss Franc peg breaks because the fall of the euro becomes too expensive to hold. Danish peg to the euro will likely also break soon if you want to take advantage of that, although that one will not be as profitable.

    Next stage the emerging markets have huge debts in dollars that are becoming more burdensome, while their economies are slowing and their commodities are bringing in less hard currency. They are going to crash. Then Europe will become insolvent again. By then the crisis will propagate to the financial sector and crash the markets globally. We will have a repetition of 2008 only bigger and worldwide. The mess is going to be more difficult and more costly to sort.

    I don’t see how the oil price could recover in the middle of a crisis. Maybe after the summer of 2016 at the earliest once the crisis bottoms. OPEC expects a demand recovery by 2017-2018 in its last report.

    Afterwards the probabilities of peak oil having been stablished in 2014-2015 are extremely high. Lots of small oil companies will have died so there will be a lot less enthusiasm to jump back in to produce expensive oil when the prices recover. And by then the economy will be in such bad shape that I doubt it will be able to afford even $110 oil as it once did.

  2. Euan: I don’t see the decreasing copper price as a harbinger of doom. The graphic below makes it look as if copper could be another bursting bubble but I don’t think it is. Unlike oil, global copper supply and demand are pretty much in balance and expected to remain so.

    And at least some of the $US price decrease since the 2011 peak has been caused by the appreciation of the $US against other currencies:

    Now watch the market prove me wrong 🙁

    • Javier says:

      I’m afraid, Roger, that markets have already proved you wrong on this one multiple times. A fall in commodity prices, of which copper and oil are two important ones, is a common feature that precedes economic crisis. In fact together with other leading indicators constitutes advanced warning of an impending economical crisis.

      In this figure of the Commodity Index I have marked with arrows some peaks in commodity prices and in pink US recessions. I have also marked the Asian crisis of 98 and the European crisis of 11. You can be the judge.

      It is not a sure thing, but together with all the other things taking place in the markets, currencies and economies, to me it is pretty clear that Mr. Doom is knocking at the door. So clear that I am going to sell my house and going renting. I already sold my previous house in 2006, but it the house market crashes again I would be under water with the mortgage for the one that I bought a few years later. Banks will not be safe either. Depositors are considered bank creditors now, so haircuts are possible.

    • Euan Mearns says:

      Roger, but if the price hits $1.5 like 2008?

      I did wonder about Cu over-supply, but forgot to mention it. And the $ can only explain so much, what about the gold price?

  3. Dave Rutledge says:

    Hi Euan,

    Timely post. For me the central issue is that no one predicted the price collapse. Economics is not a predictive science. It is also clear that the Saudis once are again are not willing to be the swing producer. In retrospect it is hard to criticize the job the Texas Railroad Commission did.


    • Javier says:

      Not true, Dave. Lots of people predicted a fall in oil prices. Oil price has been making a triangle (wedge) that in technical analysis is a common figure that very often resolves by a strong movement upwards (demand wins) or downwards (offer wins). Given that demand was showing signs of reducing and offer was plentiful, in this particular case the downward movement looked more probable.

      Technical analysts do see this figures all the time and if they are good they beat the odds consistently. See for example:

      This guy predicted it two years in advance. He was not the only one of course.

  4. Graeme No.3 says:

    David Rutledge:
    Winston Churchill supposedly said an economist is someone who can tell you afterwards how you went wrong, even though you were following his advice. I am not sure if he did indeed say it, but until you can list 3 economists who got thing right, I will continue to believe it.

  5. Sam Taylor says:


    It appears that stock market and oil market volatility have decoupled:

    I’ve had a look at some longer time series, and they seem to have been in lockstep since maybe the early 90’s. So either something strange and different is going on, or we’re due a stock market correction soon. Since corporate profits in the US and UK are currently at or near record highs, I’m less inclined to believe that the stock market is quite as huge a bubble as some, however I do question the sustainability of those profits. QE has certainly had some impact on asset prices, but I think a lot of the “QE = asset bubble” crowd overblow things a bit, I think QE isn’t anywhere near as powerful a tool as is made out.

    I have to admit I don’t believe a thing about China’s figures. How on earth do they release their full year GDP so quickly? Why is it never revised?

  6. john Pitman says:

    Euan the Baltic Dry Index is also at a 6 year low, and falling.

  7. dereklouden says:

    We’re told there is presently no chance of a recovery in price. This is far from accurate. Were the US, Russia and OPEC to sit down and manage production levels prices would certainly recover. Any two from three could fix things. Russia and the US will not sit down to discuss this anytime soon. The position in Syria and the Ukraine means this cannot be done without one side, the other or both losing face. Russia and Saudi Arabia are also unlikely to combine to sort things out by agreeing to limit production. Russia supports the Alawite (Shia) Assad regime whilst the Saudis support the Sunni rebels.
    Third possibility of a deal on production would be between the US and the Saudis. They have ruled out any agreement and are battling for market share. Were self-immolation to be abandoned then prices could be restored. More pain seems likely before common sense prevails with any of these pairings. None of these resolutions is impossible however. In any event, a return to growth in the world economy will boost prices.
    The chart below shows US imports falling faster than China & India’s are rising:
    This explains the drop of in price to some extent. The main cause is increasing US domestic production and the consequent dramatic fall in the USA’s need to import foreign oil.

  8. Askja Energy says:

    One more very thoughtful article. It would be very interesting, Euan, to hear your views on Goldman Sachs “New Oil Order”.
    Best regards from Reykjavík.

  9. Euan Mearns says:

    Thans for a great set of comments so far. The original version of this post was in fact much gloomier in its conclusions but I decided to lighten it up a bit. I personally have a sense of foreboding but that stems partly from living in Aberdeen and witnessing the slow mo train wreck. Reading the comments here reinforces that sense of gloom. There seems to be a disconnect between the USA and the rest of the world where the rest of the world is doing badly, locally very badly. Can anyone name another large economy that is thriving?

    To summarise some of the comments here:

    Javier gets the coconut for gloomiest comment:

    Global oil imports in decline. This is an interesting one since Jeffrey Brown (Westexas at The Oil Drum) was always promoting declining exports. Declining imports inevitably follow. Derek, your chart doesn’t have all countries.

    Baltic dry index at 6 year low. Looks like it can’t get much lower.

    Commodities volatility decoupled from market volatility. That’s a tough one. I guess I’d expect market volatility to return with a vengeance.

    Commodities prices ARE a leading indicator of economic health.

    One final observation to throw into the ring is the recovery in gold price. Syndroma noted a couple of days ago that Russia is a heavy buyer.

  10. Roger Andrews says:

    The conditions that preceded previous global recessions are not present at the moment.

    So if anything bad does happen it will be caused by something new. One of those “unknown unknowns” that sometimes jumps out of the woodwork and bites you in the ass.

    • Sam Taylor says:


      The closest analog on that chart to where we are at the moment is probably 1985. I was only young at the time, but I understand the late 80’s were rather go-go economically. I think you’re right that it’ll be something other than oil if anything goes wrong in the short term.

    • Javier says:

      Hmm, are you referring to an oil price-shock? That is actually not the actual condition but the “oil demand retraction” caused by the oil price-shock. Are we having an oil demand retraction now? I would argue that we do. Then it doesn’t matter if it was caused by an oil price-shock or an oil price prolonged strangling from the 2011-14 elevated prices.

      A lot of known things that may lead to a recession are taking place. Leading indicators capture some of them. The Economic Cycle Research Institute (ECRI) Weekly Leading Index is dropping like a stone into the dead zone:

      They had a misfire in 2012, but it is clearly not good news if it keeps going down.

      The yield curve is no longer giving us advanced warning and that’s too bad, but the credit spreads are still working. It is also a usual precondition that they are widening, and they certainly are.

      A recession is very hard to predict, but as John Hussman puts it, we are in the 8% of the time where recessions do take place because the conditions are in place.

      • Are we having an oil demand retraction now? I would argue that we do.

        And I would argue that we don’t:

        • Euan Mearns says:

          In 2008-09 OPEC had to cut over 4 Mbpd to restore order. And so assuming that the IEA supply numbers are correct, I suspect their demand numbers are overestimated.

          • And if OPEC had agreed to cut production by ~ 4 million bpd at their meeting last year the price of oil would still be up in the $80-90 range or wherever and we wouldn’t be having this discussion 😉

          • Euan Mearns says:

            Yes, but the last time OPEC had to do that the world was already gripped by the most serious financial crisis since 1929.

            No one knows what the finance story line is any more and I think Janet has decided that we all ought to know. A new age of discovery. Big gambol for Obama.

        • Javier says:

          I only have info for China up to the beginning of 2014, but based on GDP trend it is probable that the demand has only gotten worse.

          Also, the Chinese stock market is performing very poorly and there is information that construction companies have financial troubles. Not the conditions to increase demand.

          It is likely a widespread problem affecting all developing economies given dollar performance but if just China is slowing demand then it can be argued that there is a demand retraction. Clearly Europe and Japan are in no shape to increase oil demand being mired in deflation and lack of growth.

  11. philipdaniels818151638 says:

    The Saudis are building the world’s largest building – a market crash is therefore guaranteed 🙂

  12. bobski2014 says:

    Graph #1 shows copper in $ US. #3 shows Euro against the $ US. Roughly speaking does that not suggest that in Euro terms copper remains approximately at its high for European buyers? If that is so, might this (and other unmentioned similar commodity price relationships) not be a contributory factor to Europe’s – and Britain’s – continuing inability to stop the economic slide?

    And by the way this is no time for gamboling ! 😉

  13. bobski2014 says:

    Sorry – #4 not #3

  14. Luís says:

    Portugal is not in the Mediterranean, check your Geography.

    Chris Cook has been predicting a petroleum price collapse since 2010, on the basis that the Brent index was being manipulated. I challenged this idea repeatedly at the European Tribune, pointing that such lasting and impacting manipulation could only be achieved by building a stock large enough to “cheat” the futures curve. Chris never presented evidence for such a gargantuan stock, but he evolved his theory, first blaming Goldman Sachs for it, then BP and more recently Saudi/OPEC.

    I have repeatedly written about prices in periods of scarcity, pointing that volatility is a natural outcome. To this bust a boom will follow, that in its turn shall end in a new bust. This erratic dynamics between supply and demand is an integral part of what folk term “Peak Oil” that is poorly understood. Here is an old post about it:

    And it is never to much to say that “Peak Demand” is an absolute nonsense.

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