Crude Will Likely Follow Economy Down in 2012

 | Dec 27, 2011 | 12:30 PM EST
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My biggest concern for 2012 is the economy. In particular, I am concerned about a significant European event, contagion that crosses both the Atlantic and Pacific, and a general slowdown in worldwide GDP. In short, there is a high likelihood that crude oil prices will tumble.

Oil and the economy are linked. As the worldwide economy grows, so does demand for oil. And if demand falls, so should price.

So the economy is a critical to oil prices. Unfortunately, it looks as though worldwide GDP is faltering. In fact, a collapse could be in the making.

This time it all begins in Europe. Contrary to the happy talk, many analysts believe Europe is well beyond the point of no return. A recession is setting in as cash-strapped countries and their citizens rein in spending. The only questions remaining are, how long will Europe's recession last, and how deep will it reach?

It appears that the recession could be long and deep. Several European countries have costly social programs they can no longer afford, and recovery will be difficult if not impossible. Cutting spending is now the imperative. For most countries, a reduction in government spending cannot be offset by private spending, so the recessionary spiral begins.

That spiral cannot be limited to Europe. Major economies and companies depend on a healthy Europe. To provide perspective, the European Union's No. 1 import partner is China, and China's No. 1 export partner is the European Union. No. 2 is the U.S.

China and the U.S. will feel the European slowdown. China will really feel an impact if both the European Union and U.S. economies falter at the same time. Unfortunately, the likelihood is significant.

Just ask the International Monetary Fund's managing director, Christine Lagarde. Last week she warned, "Currently the world economy stands at a very dangerous juncture." She also spoke of a crisis of confidence with high unemployment and slowing global growth. She said, "The IMF's revised global growth forecast expected in January looked to be lower."

The U.S. appears to be particularly vulnerable. Money-center banks and Fortune 1000 companies, such as Oracle (ORCL), derive significant amount of their revenue from Europe. A European recession could drag down U.S. multinationals and cause the U.S. economy to slip into a recession.

One of those making a recession call is Lakshman Achuthan, co-founder and chief operations officer of the Economic Cycle Research Institute. In an interview with Bloomberg, Achuthan warned that the downtrend is already under way. He is concerned that it will be persistent.

Achuthan analyzed gross domestic income (GDI), among other indicators. He and others argue that the GDI is a better indicator of economic health than GDP. If the GDI runs 2% or lower, the economy goes into a "recessionary stall." For the last six months, GDI was below 2%, and the last reading was 0.28%. As The Wall Street Journal 's Conor Dougherty reports, current GDI figures show that the U.S. is near a standstill, raising fears that "third-quarter growth was much slower than GDP figures suggest."

It's not just GDI. A number of industries are warning, particularly the shipping industry. According to CalculatedRisk, traffic at the ports of Los Angeles and Long Beach are already declining. Inbound traffic is "rolling over," and outbound traffic has stopped increasing.

As Robert Wright reports in Shipping and Logistics, just nine months ago the tanker industry was looking at China's growing appetite for oil. "Since China was increasingly sourcing its oil from far away, overall demand for tanker shipping was growing." That optimism reversed six months later, and now shippers are looking to convert their fleets into scrap metal. According to Dagfinn Lunde, head of shipping at Germany's DVB Bank, "We do see it getting worse before it gets better."

It appears that demand for oil is already declining. Price must soon follow. Some analysts are warning that a decline in prices could be significant.

Steve Briese is one of those analysts, and he has an impressive track record. Briese's recent analysis concludes that crude oil markets are ready to turn down, possibly hard and soon. Briese finds non-spreading open interest, no new bulls and a lot of short-selling. He is looking for oil's recent lows to be "taken out."

For 2012, it appears prudent to trim oil positions (but if Iran or North Korea decides to become belligerent, all bets are off). One way to trim is to sell oil-sensitive equities. These include Exxon Mobil (XOM), Royal Dutch Shell (RDS.A), BP (BP), ConocoPhillips (COP), Chevron (CVX) and Total (TOT).

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