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The Oil story is being misinterpreted by many investors.
When it comes to Oil, OPEC matters, as does Oil Shale, production
cuts, geopolitical risk, etc. However, the reality is that all of these are minor issues against the MAIN STORY: the $9 TRILLION US Dollar carry trade.
Drilling for Oil, producing Oil, transporting Oil… all of these are extremely expensive processes. Which
means… unless you have hundreds of millions (if not billions) of Dollars in
cash lying around… you’re going to have to borrow money.
Borrowing US Dollars is the equivalent of shorting the US DOLLAR. If the
US Dollar rallies, then your debt becomes more and more expensive to finance
on a relative basis.
There is a lot of talk of the “Death of the Petrodollar,” but for
now, Oil is priced in US Dollars. In this scheme, a US Dollar rally is Oil
negative.
Here’s
the US Dollar:
Here’s a chart showing an inverted
US Dollar (meaning when the Dollar strengthens, the black line falls) and Oil
(blue line):
Oil’s collapse is predicated by one major event: the explosion of the
US Dollar carry trade. Worldwide, there is over $9 TRILLION in borrowed US
Dollars that has been ploughed into risk assets.
Energy projects, particularly Oil Shale in the US, are one of the
prime spots for this. But it is not the only one. Emerging markets are
another.
Just about everything will be hit as well. Most of the “recovery” of
the last five years been fueled by cheap borrowed Dollars. Now that the US
Dollar has broken out of a multi-year range, you’re going to see more and
more “risk assets” (read: projects or investments fueled by borrowed Dollars)
blow up. Oil is just the beginning, not a standalone story.
If things really pick up steam, there’s over $9 TRILLION worth of
potential explosions waiting in the wings. Imagine if the entire economies of
both Germany and Japan exploded and you’ve got a decent idea of the size of
the potential impact on the financial system
And that’s assuming NO increased leverage from derivative usage.
The story here is not Oil; it’s about a massive bubble in risk assets
fueled by borrowed Dollars blowing up. The last time around it was a housing
bubble. This time it’s an EVERYTHING bubble. And Oil is just the canary in
the coalmine.
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