Oil Rally, Dollar Drop Triggered Risk-on Trade: CLSA’s Wood
Mumbai: Christopher Wood, managing director and chief strategist of Hong Kong-based brokerage and investment bank CLSA, said the rally in crude oil prices and weakening of US dollar have been instrumental in effecting a transition from ‘riskoff ’ trade to ‘risk-on’ trade since mid-February. Risk-on, risk-off refers to investor behaviour and their willingness to take risk. Periods of perceived low financial risk encourage investors to make higher risk investments, creating a risk-on situation.
Crude oil rally has caused dramatic decline in yields in the most distressed part of credit markets, namely high-yield energy bonds. The average yield on US high-yield energy bonds peaked at 20.75% in midFebruary, and has since fallen to 11.56%, said Wood.
If crude oil prices suddenly drop again, taking most likely the rest of the commodity complex with it, then there is overwhelming likelihood that the US dollar rally will resume, and the financial world will move back into “risk off ” trade as default risk rises, because there has been a 96% correlation between the dollar and oil since 2013, he said.
Wood said oil inventories remain high and continue to rise in America and Europe, with rising storage capacity utilisa- tion. US commercial crude oil inventories rose 10.1% to record 538.6 million barrels in the week ended April 15.
There were expectations of a production freeze going into the OPEC-Russia summit last weekend in Doha, which was a failure. But, the fact that oil has not sold off has also encouraged those who believe that oil has bottomed on the view that the industry has started to adjust, with US crude oil production having declined by 6.8% from its recent peak of 9.61 m barrels per day in June 2015 to 8.95 m barrels per day last week, said Wood.
Natural gas prices are now back at levels that prevailed in the 1990s, and are down by 86% from the highs of late 2005, while US shale gas production has continued to increase despite the collapse in prices because of continuing falling costs.
US shale gas production rose 9.2% to a peak of 43.1 billion cubic feet per day in January, and was 42.6 bcf/d in March, according to the Energy Information Administration. Wood said people expecting a steep decline in US shale production may be disappointed.