Equities find support from lower crude oil

Crude oil prices have declined sharply in the recent past. Since 1 April, Brent crude prices have declined by 23% to $92.6 per barrel. The economic problems in Europe, higher supplies in the US and tensions in Iran are the obvious reasons but, more recently, prices seem to be declining also because of a slowdown in China and India.

On Thursday, the HSBC Flash Purchasing Managers’ Index indicated China’s industrial activity contracted further in June, the eighth consecutive month of shrinkage. And, of course, growth has slowed sharply in India as well.

The recent decline in crude oil prices has also broken an important correlation between asset classes, as the chart shows. Till the recent past, the BSE benchmark Sensex and crude oil prices used to move in tandem, but that’s not happening now.

Crude oil and the Sensex have enjoyed about 90% correlation in the last 10 years, but this trend has been broken in the recent past, said Saurabh Mukherjea, head of equities at Ambit Capital Pvt. Ltd. For example, Brent crude has declined by 22% since May, whereas the Sensex has declined by just 2.4%. “Crude oil prices have become more realistic and seem to be following more fundamental factors such as the demand and supply dynamics now,” said an analyst.

Will this trend continue? “For this to sustain for a longer period of time, some factors need to play out. For one, China’s growth prospects need to be significantly weaker and, at the same time, the Indian economy would have to see some positive changes in the form of better reforms. Moreover, the western world needs to see another round of quantitative easing,” added Mukherjea.

For now, the weak crude price is definitely one reason to rejoice. The crude oil price for the Indian basket fell to $94.03 a barrel on 20 June from $120.58 per barrel in the first fortnight of April, according to data from the Petroleum Planning and Analysis Cell.

Despite the fall of the rupee, the price in the local currency for the Indian basket has also fallen from Rs 6,174 per barrel in the first fortnight of April to Rs 5,252 on 20 June.