The recent drop in the oil price is just the start of a longer term decline, according to managers at OpenMind Asset Management, the Paris-based firm seeded by La Francaise Asset Management.
Fund manager Tristan Abet first warned about the vulnerability of oil prices in March, since when there has been an overall slide, which “brings an important message for us”, he says.
“While some would say it is just the consequence of its correlation with the equity asset class, we think there is something else. We see four reasons behind this move. The economic slowdown in emerging economies appears more pronounced than expected, and the corollary of this disappointment is the de-rating of oil prices. The benefit of the doubt previously given to oil, with the potential status of a ‘growth asset’, is thus vanishing.”
Additionally, rising tensions within the OPEC, the producers’ cartel, and the fundamentals of the market, summarised by the ‘peak oil’ theory, are becoming less relevant.
The key question, according to Abet, is if there is a limit to the decline. “The economic reality still does not support any bull case on this asset, while the market behaviour exhibits a marked downward momentum,” he warns.
From a fundamental view, there is no structural imbalance between supply and demand. Spare capacity is 10% above its 10-year average. World oil demand for 2012 remains in line with the forecasts at the start of the year, meaning a modest growth of 1%, which does not fit very well with the definition of a ‘growth asset’. Further, price/demand elasticity tends to increase in this context of moderate growth.
With one of the worst Sharpe ratios year-to-date, oil’s potential status as a growth asset is gone, says Abet.
He considers commodities primarily as listed financial assets, which have acquired a new status over the last decade because of investors’ “obsessional search for growth”. Emerging markets benefited because they fitted well with this search, becoming part of a “super-cycle” from 2003, which was only dented by “a first alert” – the reversal of the equity market in 2007.
But in 2008 emerging markets were drawn into the global financial crisis sparked by the collapse of Lehman Brothers. The theory of de-coupling of emerging from developed markets was shown as an illusion.
“The second and last alert is now, in 2012,” says Abet. “And it is again the signs of economic weakness coming from emerging countries. That is clearly the main reason behind this change in status. 2012 will remain the year during which oil, like several other commodities, are back as simple value assets.”
He added that investors “face a huge moral hazard as a lot of agents have organised their economic system by taking for granted that oil prices would be in an eternal upward trend”.
Over one month, spot prices declined by $14 while five year futures prices only declined by $4. “Investors have therefore still not capitulated and still consider the current movement as a temporary correction. We do not share this view,” he said.