Watch the metal prices

The reason for the oil price drop is important and a lot depends on how strongly the world’s economies are growing as a whole

elcome to 2015 . . . It may already be mid-January, but most southern hemisphere businesses are only getting back to full capacity this week after the holiday season. So what does this year hold for us? The big surprise of late 2014 was the plunge in oil prices — from around US$110/barrel in the first half of the year to US$50 at year-end. On its own, this development is unequivocally positive for SA, and much of the rest of the world. In late December, the IMF found that the recent drop in oil prices would boost global growth by “between 0,3% and 0,7% in 2015”.

Unfortunately, in the real world the ceteris paribus assumption (all other things being equal) does not apply. The IMF’s estimate compared the growth outcome only “to a scenario without the drop in oil prices”. Outside the economic textbooks, the reason for the oil price drop matters. Is it simply because Opec has stopped providing a buttress for the oil price as some of its members attempt to purge the market of higher-cost production? Or is it a sign that the pick-up in global growth continues to disappoint?

Historically, metal prices have been more sensitive to growth prospects than oil prices. However, metal prices have fallen far less than oil prices in the last six months. Perhaps this is because metal prices started falling in late 2013, and the oil price is only catching up. If this is true, we should not read the plummeting oil price as a sign of impending global economic doom.

Goldman Sachs points out that this sell-off has been driven by long-dated prices. “Because the surplus is supply-driven, it is easily observable in the future, unlike demand shocks that are instantaneous, so the market is trying to rebalance the future, not so much the present.”

If this is true, then the elevated oil price in mid-2014 was the problem — and reflected something of a “Saudi put”, with notable similarities to the Greenspan put. In the late 1990s, then US Federal Reserve chairman, Alan Greenspan, repeatedly lowered interest rates to prop up the financial markets. Eventually, deteriorating real economic growth meant Greenspan could no longer artificially induce share price strength with cheap money. Similarly, it seems that the Saudis decided that artificially keeping the oil price higher in the face of surging global oil supply was unsustainable.

While oil exporters will face pressure on both the fiscal and current accounts, most emerging markets and developed countries should benefit. For SA, this is a halcyon view of the world.

Let’s start with the inflation outlook. I’d guess the SA Reserve Bank used an oil price assumption of around US$85/barrel in its forecasts ahead of the November monetary policy committee meeting. Replace that with US$60 (20% higher than the current level of US$50), and the (SA and global) inflation outlook for 2015 nosedives.

Though the impact on core inflation will be more muted, there will be second-round benefits if the oil price remains low. Therefore we could see interest rates on hold through 2015, despite a small uptick in US rates. (US rates are also not likely to rise much if their inflation outlook is subsiding.)

Lower fuel prices will also boost the average consumer’s disposable income. This support for growth will be a boon, given SA’s electricity constraints.

If metal prices do not fall much further, the lower oil price improves the terms of trade and should (finally) result in some improvement in the current account deficit in early 2015. This should ease pressure on the rand.

The main risk to this placid outlook for 2015 is global growth that is actually weaker than is commonly estimated. In this scenario, metal prices would continue to fall. The improvement in SA’s terms of trade would therefore be temporary, the rand would continue to depreciate and interest rates would need to rise. Moola is an economist & strategist

at Investec Asset Management