It all depends on the oil price

OVER recent weeks we have seen what could be the start of a recovery in our financial and industrial sectors, however whether this recovery is sustainable all depends on the oil price, says Mark Appleton, Chief Investment Officer at BJM Private Client Services.

Appleton says when the oil price ran up nearly 40% in June; the full extent of the surge could not entirely attributed to a tightening of supply or escalating demand. “There was evidence of speculation which contributed to the extent of surge. Since then we have seen clear signs of demand destruction, so it is not surprising to see the oil price coming down from those levels,” says Appleton.

Appleton says the oil price has an 85% negative correlation to the equity markets and therefore globally, financial markets have the potential to recover as long as the pace of oil price hikes eases.

Appleton says the inflation fears as a result of the rapidly rising oil price forced central banks to focus on inflation containment rather than economic growth. A softer oil price will provide for more flexibility with regards to monetary policy. “Even if the oil price was just to rise more slowly, this would provide an opportunity for the financial markets to recover as central banks would be able to follow a more accommodative monetary policy to offset economic weakness,” says Appleton.

Appleton says the oil price is likely to stabilise at lower levels. Speculative activity should be limited as the US congress has placed speculative trades under the spotlight. Given the continued evidence of demand destruction, this could see the oil price remain below $120 per barrel. “Those levels would allow for softer monetary policy which would then feed into boosting economic growth and benefit the markets” says Appleton.

However Appleton remains cautious on local interest rates and is anticipating one more 50 basis point rate hike. “Unlike the US, our Reserve Bank does not have a duel mandate and thus gives less attention to economic activity when making interest rate decisions. Unfortunately this runs the risk of an overkill of the South African economy”.