The litmus test for the global economy

Oil prices have moved into another ‘flag shape’ – which previously provided critical warning of the March collapse, and of those in 2014 and 2008. The shape is important as it means the bulls and bears have been battling each other to exhaustion, making it likely one or the other will give up.

This time, the range is narrower as the chart shows. It suggests the promised V-shaped rally stalled at the end of May. And as I have already warned, it is now clear that the rally was really only due to massive stock-building by China and India, as Reuters now confirm:

  • “China waded into oil markets in April when prices collapsed to multi-decade lows, snapping up cargoes for delivery in coming months.
  • 120mb of crude was still waiting to discharge on 23 July, with ports frantically building new storage capacity to receive the cargoes
  • There is already enough commercial crude storage to supply China’s total needs for 3 months at 2019 rates, before the waiting cargoes unload
  • Meanwhile, India’s storage was “completely full” by May, and demand remains weak due to the pandemic

Plus, of course, China is suffering its worst flooding for decades.  These will inevitably further setback recovery hopes, especially as extreme weather conditions are also impacting other major Asian economies.

WHAT HAPPENS IF THE CENTRAL BANKS HAVE BEEN WRONG?

My argument here since early February has been that the Covid pandemic is simply the catalyst for major paradigm shifts in world markets.  But as usual, the central banks have stuck to their argument that demographic changes are irrelevant to the global economy.

But it is now becoming increasingly clear that they are wrong, again.  Instead, we are seeing a collapse of demand, which is starting to create a series of major bankruptcies in industries such as travel and leisure, retail, commercial and residential property, as well as energy and petrochemicals.

In addition, we have geopolitical issues starting to take centre stage, with US Secretary of State Mike Pompeo confirming that a new Cold War is underway – this time between the USA and China.

In turn, other countries and regions are starting to take sides. One of the first moves has been by Iran, which has begun to develop an ‘energy for security’ pact  with China – its partner in the Belt & Road Initiative and the world’s largest user of oil and petchems.   As the New York Times reports:

“The partnership would vastly expand Chinese presence in banking, telecommunications, ports, railways and dozens of other projects. In exchange, China would receive a regular — and, according to an Iranian official and an oil trader, heavily discounted — supply of Iranian oil over the next 25 years.”

It would therefore be no great surprise if the next act in the drama is a fall in the oil price.

A number of key developments suggest the recent Rebound is over, after the end of the lockdowns. Interest rates have begun falling again around the world, along with inflation, whilst gold prices have been rising on ‘safe haven’ hopes.

So what would happen if oil/financial markets start to fall again?  Most likely, attention would turn back to the IMF, and their suggestion we should expect a decade-long depression scenario where deflation would become embedded in the economy.

This would fit, of course, with the demographics. As the chart confirms, over 50% of the 750m global population increase over the next decade will be due to the Perennials 55+generation.  And whilst increasing life expectancy is great news for individuals, it is bad news for economic growth:

  • Perennials already own most of what they need
  • And their incomes are set to decline as they enter retirement

So if/when the oil price starts another descent, tt would seem prudent to assume that March’s original downturn will then resume.  Companies and investors need to prepare to activate their contingency plans to survive the IMF’s decade-long depression,