Equities: crude vs extra virgin oil

What would oil magnate JR Ewing of ‘Dallas’ do today?
JR Ewing played by Larry Hagman © CBS Photo Archive/Getty

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Does this sound familiar? “Equities have been unusually highly correlated with moves in the oil price . . .” “A striking correlation between falling oil prices and the big stock market indices . . .” “Oil and stocks are being correlated by a single issue . . .”

If you are on the mailing list of Seven Investment Management, Rothschild Wealth Management or US Bank’s Private Client Reserve, it probably will do. Since the start of the year, they have been among the many advisers to blame the falling price of black gold for their inverse Midas touch on your portfolio. Bank of America Merrill Lynch even bemoaned oil’s 90 per cent intraday correlation with equities and bonds as “too extreme for reality”.

But the next time your investment manager appears as wrongfooted as Cliff Barnes facing down JR Ewing at the Oil Barons’ Ball in the 1980s TV series Dallas, try asking this question: “If $30 oil is so calamitous, why didn’t you hedge the risk by buying the one variety perfectly negatively correlated to stock markets? Not Brent Crude. Nor West Texas Intermediate. Nor Sumatran Light.”

Extra virgin olive.

While the price of a barrel of crude has fallen 47 per cent in the past 12 months, the price of a bottle of olive oil has risen by about 20 per cent — after bad weather and disease devastated the last European harvest.

As a result, the multiple of the olive oil price to Brent Crude has leapt from five times in June 2014 to 17 times last month.

Judging by most wealth managers’ communications, however, their allocation to this, or any other, uncorrelated asset class is little more than a drizzle. In fact, some suggest their performance might only have been worse had they emulated Sue-Ellen Ewing in a Dallas cocktail bar: long on crude, short on olives.

Many see falling crude oil prices as a proxy for growth rates. Kevin Gardiner, global investment strategist at Rothschild Wealth Management, is quick to remind clients that stock markets have had their worst start to the year since 2009 after “China’s stock market, and crude oil prices, fell sharply, threatening another round of financial contagion”. Pau Morilla-Giner, chief investment officer at London & Capital, names oil as one of the main “pressure points” for equity markets. And Rajesh Tanna, senior portfolio manager at JPMorgan Private Bank, warns that “share prices are reflecting growing concerns about a China slowdown and lower oil prices, and their implications for global growth”.

Linda Gray as JR's oft-drunk wife Sue-Ellen © CBS Photo Archive/Getty

Why, though, are so many wealth managers convinced that lower oil prices are bad for shares, when their effect is to reduce companies’ costs, lifting their profits and dividends?

Is it because of the dominance of energy companies and banks in benchmark indices? And hence their client portfolios?

Or is it because oil has become a unit of international exchange for the wealthy — and its devaluation affects their view of other asset classes? Texan oil barons, sheikhs and oligarchs are now quoted property prices in barrels of crude. In January, investment bank Jefferies said it cost 90 barrels of oil to purchase one square foot of London’s prime West End floorspace, compared with 20 barrels a year ago. Similarly, Deutsche Bank recently noted that an ounce of gold now costs more than 40 barrels of oil — making JR’s bathroom fittings more expensive than ever. In fact, according to Deutsche analyst Jim Reid, gold taps now cost more in oil terms than at any time since 1892.

Or is it really because too many wealth managers mistake correlation for causation? Alan Higgins, chief investment officer at Coutts, says: “A special feature of this January was the equity markets’ almost slavish following of oil prices, which have been interpreted as signalling a collapse in global economic growth. But the reality is that oil prices have been in steep decline for about two years, during which time crude demand has actually been going up. In fact, low energy prices are good news for consumer spending.”

Jonathan Bell, chief investment officer of Stanhope Capital, agrees: “The fall in the oil price reflects excess supply growth rather than a fall in demand: supply and demand have both grown in recent years but supply has grown faster.”

If there were a real demand problem, we would see non-performing loans rising in all industry sectors, not just in energy, argues Frédéric Lamotte, global head of markets and investment solutions at Indosuez Wealth. “Lower oil is good for growth,” he insists.

Indeed, Lamotte’s view on cheap oil is not dissimilar to the defence for shooting JR Ewing: “It [harms] a small population compared with people going to benefit,” he says.

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