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Oil price rises are odd things. In their initial phases they tend to attract a cautious welcome from economists, especially when those economists are alert to any sign of the global economy recovering sustainably.
However, it’s a knife-edge judgment and rising prices soon shift from being an encouraging sign of global growth to a dangerous headwind.
And we’re there or thereabouts now, it seems, with the price of a barrel of Nymex crude up some 45% since the October 2011 low.
Sure enough, here’s UBS’s Bhanu Bhaweja, global head of emerging market fixed income and foreign exchange research at UBS Investment Bank:
“Intra-commodity signals are now showing worrying signs; for example, copper is struggling to rally as oil is pushing higher. This may suggest we are in early stages of demand being squeezed out by high energy prices. A continuation of this pattern will not be what the doctor ordered.”
So, rather than spotting growth, analysts are busy looking for threats to it. And those at Royal Bank of Canada Capital Markets reckon to have found a good one.
They like to look at the price ratio of oil to copper. This gives a more nuanced picture as oil is a commodity for which demand is relatively inelastic over the economic cycle and copper isn’t.
Over the past four years, they said, there has been a “very tight relationship” between the ratio and global economic conditions, as well as financial market returns.
In fact, the relative prices of these important commodities appear to offer us a highly dependable forecast, with six months’ advance notice, on the future trend in economic and market performance.
Correlations are very high between the copper/oil ratio and the global purchasing managers’ index, for example. Indeed they have a four-year correlation of 0.86. The ratio’s correlation with returns across global and emerging-market equity is also high, at 0.85.
So, a very useful leading indicator then; indeed given those high correlations and that time lag it could be all you need to watch, but here is the bad news. Current levels of the copper-to-oil ratio are consistent with the global PMI dropping into a very weak 40-45 range, RBC said; global equity indexes registering 15% losses and emerging-market currencies weakening 15% from their recent highs by the summer, consistent with revisiting the lows of early October 2011.
Copper and oil are telling us the risk switch is going to flip back to "averse" again, probably for a while.
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The Source is WSJ.com Europe’s home for rapid-fire analysis of the day’s big business and finance stories. It is edited by Lauren Mills, based in London.
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