Oil Correlated To Equities & Risk Appetite
Industrial commodities such as energy and base metals are highly correlated to risk appetite and hence equity markets. Below I highlight the monthly rolling correlation between Brent crude and the Dow Jones. The two main things to note are that first, on a monthly basis, the correlation stands at 0.9 (which implies a strong and positive correlation), which is its highest level in recent several years. Secondly, I see potential for this correlation to remain in place for some time as cheap money finds its way into ‘risky assets’ such as equities and industrial commodities, particularly energy and industrial metals.
Going forward, I expect to see sideways trading for equity markets and in turn oil prices. Indeed, I think oil will likely trade within the wide range of US$70-84/bbl, and do not rule out a break out of this range in either direction, although I hold a downside bias if anything. Oil prices typically remain well supported in Q3 as the US driving season is compounded by increased hurricane activity in the Gulf of Mexico. However, data shows that the driving season has been somewhat lacklustre thus far, and the hurricane season has not yet caused much concern, although it could still pick up in coming months. With these trends in mind, and potential for a downside surprise in China’s growth numbers in coming quarters, I see oil as being highly susceptible to negative changes in risk appetite.