In Hart Energy Research's 2Q2011 Oil Price Forecast, we reiterated our second-half 2011 outlook of $91 per barrel for West Texas Intermediate (WTI) crude oil. Citing continued concerns about economic conditions in the euro zone, and the end of QE2, along with high unemployment in the U.S., we expected this negative economic data to put downward pressure on demand and oil prices. In our crude oil price research, we have also taken into consideration three key financial parameters—the gold price, the S&P 500 index and the U.S. dollar exchange rate—that strongly correlate with the movement of crude oil prices.
Gold
The price of crude oil generally shows a positive correlation with the price of gold, which, similar to oil and other commodities, has become a safe haven for investors. Memories of the 2008 financial crisis still make investors uneasy about the health of the global economy and have led them to buy gold as a way to diversify from traditional asset classes while realizing profitable returns.
Hart Energy Research expects gold prices to continue to test new highs through the duration of our short term-outlook to 2013. We expect negative interest rate and debt issues in the U.S. and euro zone, combined with inflationary pressures in China, to act as the primary foundation for continued strong demand. Also, both institutional and personal investors will continue to invest in gold as a hedge against traditional investments, pushing up the demand for the precious metal.
Our view is supported by the amount of gold bullion that Western governments typically own as a percentage of their reserves, as opposed to China's holdings. According to July data from the World Gold Council, the U.S. and Germany hold over 70% of their reserves in gold, while China's gold position is less than 2%. If China wanted to increase its bullion holdings, as South Korea and Thailand did in the past couple of months, it would again fuel the ongoing price hike.
In line with high volumes of total open interest, indicating total liquidity and contracts being traded for a particular security, the net position for the Comex gold contract has also been net long for some time. The flow of money into gold has become even more pronounced, resulting in prices reaching an all-time record above US$1,700 per ounce in August, as the U.S. stock market headed for one of its longest slides in decades on August 4 on the back of negative economic news. European and Asian markets also declined dramatically.
S&P performance
Traditionally, the price of crude oil has been negatively correlated with the performance of Standard & Poor's 500 indexes. However, in recent years, especially after the financial crisis in 2008, oil prices started to follow the movement of the stock market. This has coincided with the gradual economic recovery and growing oil demand. We've seen this relationship stay intact for much of 2011, with the commodity rally bolstering much of the positive gains seen in both the S&P and broader financial markets. While we could see a few market rallies throughout the rest of the year, a strengthening dollar and concerns about the recovery would cap any major gains.
Dollar exchange rate
As the underlying pricing currency for crude oil, an increase in the value of the U.S. dollar puts downward pressure on the price of crude oil. The U.S. Dollar Index (DXY) indicates the relative strength of the dollar against six major world currencies, with the euro weighing over 50%. On the other hand, a weakening dollar usually boosts the appeal of crude oil as an alternative investment.
Yifei Wan also contributed to this report. Hart Energy's 2Q2011 Short-Term Oil Price Forecast (OPF) was issued June 30.
For more information about Hart's new oil-price-forecasting service, contact Conrad Barnes at cbarnes@hartenergy.com or 713- 260-6455.
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