The Importance of Oil

Before the leading indices broke out to fresh 52-week highs in May, I highlighted the recovery of the economy from the winter in a quarterly webinar and on the Financial Sense Newshour. The only concern I had at the end of last week, was the non-stop trek since David Tepper’s “nervous time” warning – up 13 of the last 16 trading days (as of June 9th). Nothing goes up forever without a healthy consolidation. We’re getting a dip now off of sentiment, profit taking, and now finally a conflict in Iraq that was long overdue. The other caution I would put forward is the importance of the price of oil. If speculators push the price of oil to levels that hurt the economy, it could cause the elusive 10% correction that so many have called for in the past year.

The conflict in Iraq was inevitable; it’s more a surprise it has taken so long since troops were finally removed in December of 2011, right as the Arab Spring was in full swing. The conflict is based on the Shia from the south and the Sunni from the north that is as old as the schism that occurred after Muhammad died in 632. You have a civil war in Syria with a Sunni-majority and now a civil war in Iraq with a Shiite-majority-led government. Americans spent valuable lives to secure democracy within Iraq, but the Shiite-majority have done much to burn bridges instead of build them with the Sunni. The result is an uprising from the 32% Sunni that want to have representation and a voice. The downside is that many of the militant jihadist groups, like the Islamic State of Iraq and the Levant (ISIS), have joined the Sunni in organizing a militant front to the protests.

The religious heat map below shows how the region is split, and as you can see, each need to coexist within each country; however, one is usually the majority while the other the minority. In truth, it would probably be easier to redraw country boundaries than force these two groups to coexist. There’s the rub. It will be interesting to see Iran's role in the region as they are mostly Shia.

Source: Washington Post

Stock investors and oil investors had largely ignored the Arab Spring and the Syrian conflict. Even the Ukraine, Crimea, and Russian conflict have largely been ignored by investors after previous flashes of concern. It is my belief that Iraq will be no different. U.S. dependency on foreign oil has dropped significantly and we are less prone to spikes in the price due to events overseas; however, the world is not so big and what happens in the Middle East, if the conflict expands, could draw investor attention.


Crude’s .48 rise on Thursday was a technical breakout with a target of 2 just based on the technical pattern. The chart on oil has been rising since January and energy stocks have been among the best performing sectors of 2014, taking the baton from healthcare in March as a result of the Crimean conflict. Russia has threatened to cut off energy supply to the Ukraine (and possibly Europe as a result of economic sanctions). The threat has turned Europe to begin reassessing where it gets its energy from, especially as America’s energy renaissance continues to expand our production capacity and possible exportation of energy. Cheniere Energy (LNG) and Gas Natural Fenosa recently announced a deal on June 2nd some believe worth billion. Spain’s other utilities, Endesa and Iberdrola, have also signed similar agreements.

As I mentioned in the PFS Group Q1 Webinar, since 1976 increases in the price of energy have had the highest correlation to 10%+ corrections than valuations, interest rates, or Fed tightening (see image below). The development of a fresh rise in energy prices will need to be watched by even the most bullish of economic forecasters. A 2% drop in the Dow Transports today definitely flags the importance of watching energy prices as the Transports have done a good job of leading the markets higher since January of 2013.

Source: PFSGroup

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Wealth Advisor
ryan [dot] puplava [at] financialsense [dot] com ()