Gas Prices Bounce Back

November 24, 2008

(bettertrades) - Monday's record rebound in the front-month crude contract highlights a glaring reality facing the global economy: Low oil prices could be an ephemeral relief. While stocks wallow around multi-year lows, gas prices have plunged from all-time highs set this summer. Fears revolving around this summer's energy crisis have been pushed to the back-burner while the Treasury and Fed deal with meltdowns at some of the nation's largest financial institutions. The January contract jumped more than 8% midday to trade above $54/bbl after the S&P climbed 5% on the shoulders of the Citigroup bailout. While faulty forecasts like Goldman Sachs' $200/bbl prediction seem unlikely over the short-term, consensus on Wall Street for oil and other commodity prices' long-term outlook is bullish.

What does Monday's rally imply and where do gas prices head from here? Crude prices are trading with a very strong correlation to the dollar and equities. Cuts in production by OPEC have done little to stem the tide of declining prices. Yet over the past few trading sessions, crude has been unable to break below $50 support.

Highlighting the dollar correlation, oil prices touched all-time highs around the time the dollar hit a record low against the euro. For traders, monitoring the dollar can signal how to trade directional moves in oil prices. When worldwide currencies appreciate relative to the dollar, oil prices tend to increase. Alternatively, if the dollar appreciates relative to worldwide currencies, oil prices are likely to fall. Current market turmoil has sent investors running for cover in the Treasury market, boosting demand for dollars.

Equities are standing in for the supply/demand function of oil prices. Supply and demand is the largest determinant for oil prices. China and India's enormous growth has added millions of new oil consumers to the market. While Americans make up roughly 25% of worldwide oil consumption, developing nations are supplementing the demand side of the equation at an exponential rate. Considering the supply of oil is fixed, increasing demand can only make the price of oil rise over time.

Until systemic risk abates, it seems likely that oil prices will remain in check. But a strong probability remains for long-term fundamentals pointing to inflationary pressures that could make this summer's energy crisis look like a drop in the bucket.