Noted international economist Paul Krugman’s blog is called “Conscience of a Liberal”. In one of my regular visits to his blog, I noticed his reference to an article written by well-known investment guru Marc Faber in 2004. Faber had been prescient on the crude oil price in that article: “…And, in the case that oil prices were to rise in real terms to their 1980s highs — well over $100 — then the foundation for World War III would be laid and most certainly begin to weigh heavily on equity prices for which I cannot share the prevailing widespread optimism anyway…” The article is well worth a read and it can be found at http://www.ameinfo.com/47129.html.
Faber was not engaging in scaremongering.
The price of crude oil is now well past $100 per barrel and has shot up 25% in the last two months. Financial market analysts and strategists are quick to dismiss the upward trend in commodities as speculative, for it interferes with their unwavering and unrelenting plug for equities, regardless of the outlook for economic growth and corporate earnings. Plugging stocks is supposedly fundamental and God’s work while buying commodities is speculative and devil’s design.
A quick glance at the facts would show that while it is convenient to dismiss the rise in commodities as speculative, it is not correct.
Production of crude oil has stagnated at around 84 million barrels per day (mbpd) for the last four years. The earlier big oil producers such as Indonesia and the UK do not figure any more in the world’s top 15 producers. In other words, oil production has peaked in those places.
China’s per capita oil consumption, which was just under 0.7 barrels per annum in 1985, has tripled to just under 2.1 barrels in about two decades. China continues to import huge quantities of crude oil. Its import of crude oil jumped to 17.3 million tonnes (mt) in March from 12.8mt in December. It has gone up every month in the first three months of the year. This clearly puts paid to the claim that economic activity in the country is either slowing or is sought to be slowed. With this voracious consumption, what would happen if China becomes a middle-income country such as Mexico, let alone a developed nation in GDP (gross domestic product) terms such as the US?
Mexico’s per capita GDP in purchasing power parity (PPP) terms has gone up by just under three times in the last quarter century to around $12,000. China’s per capita GDP (also in PPP terms) has gone up a little more than 18 times to reach around $4,600 by 2006. If China’s per capita oil consumption were to reach Mexican levels of 6.8 barrels per annum from the current 2.1 barrels, it would overtake America’s total oil consumption of around 20.7 mbpd in 2006.
China would consume 24.8 mbpd (versus 7.2 mbpd in 2006). Even then, its oil consumption per capita per annum would be less than 30% of America’s. India’s per capita oil consumption was 0.8 barrels per day in 2006. If it were to catch up with China’s per capita consumption, India would consume 6.2 mbpd against the 2.6 mbpd in 2006.
Given stagnant production in the last four years, how realistic is it to expect that production would catch up with the surge in consumption implied by these modest assumptions? Therefore, now, does $200 per barrel of oil sound speculative or too conservative a forecast?
One colleague asked me how it is that the world economy survived the rise in the price of crude oil from $15 per barrel (it is not a typo) in end-2001 to $115 now. In the same breath, he also commented that inflation was now a global phenomenon and not confined to housing. The answer to his question and the explanation for his observation are the same.
Most central bankers across the world have run an enormously loose monetary policy over the last six years. That explains the “robust” world economy in the face of the relentless rise in the price of crude oil and the universal and pervasive inflation we see around us. It is a confession of ignorance to dismiss the rise in commodity price as speculative, faced with such compelling facts.
Now that $100 per barrel has been firmly entrenched and forecasters, including oil producers, are setting their sights on $200 per barrel, perhaps it is important to start preparing one’s portfolio for the third world war.
That would mean buying gold and agricultural commodities after the correction in the last few weeks, maintaining at least a small exposure to crude oil at all times and exiting equities after their recent run driven in equal parts by speculation, ignorance and escapist logic.
V. Anantha Nageswaran is head, investment research, Bank Julius Baer & Co. Ltd in Singapore. These are his personal views and do not represent those of his employer. Your comments are welcome at firstname.lastname@example.org