David Rosenberg is chief economist with Gluskin Sheff + Associates Inc. and author of the daily economic newsletter Breakfast with Dav
There seems to be this view promulgated by many a pundit that the slide in oil prices is a negative for the global economy.
Of course, this seems evident by the action in the stock market that, after all, rallied all the way from the early-2009 lows in oil up to the mid-2014 highs.
There seems to be a tight positive correlation now between oil and the stock market whereas in the past the relationship was inverse – in past cycles, lower oil prices were considered a bullish factor for equities but now it is the action in the stock market that has led so many to believe that a recession is around the corner. (Never mind that the stock market has "predicted" 27 of the past 11 recessions!)
But the link between oil and the stock market is actually less about fundamentals and more about fund flows – and what I am talking about specifically is the activity of global sovereign wealth funds.
At last count, there were seven oil-dependent countries that control nearly $4-trillion (U.S.) of assets (54 per cent of the global tally). These wealth funds channelled their petrodollars across the world's equity markets during the bull run in oil, which is why there was a tight positive link between crude and stock prices.
This movie is now running backward.
Those who claim that "break-even" price levels on Middle East oil production are in single digits are only looking at covering direct production costs and are ignoring the fiscal break-even levels. As per the International Monetary Fund, the fiscal break-even oil price for Saudi Arabia is nearly $96 a barrel (hence the government seeing a 20-per-cent deficit-to-GDP ratio); $68 a barrel for the United Arab Emirates (deficit of 4 per cent of GDP); and $58 a barrel for Qatar (budget gap of 1.5 per cent of GDP).
According to estimates I have seen, as of the end of 2015, 56 per cent of the assets that sovereign wealth funds had amassed came from the oil and gas related projects and up to 10 per cent of the total money invested was in global markets.
What has happened is that many governments, especially in the Gulf region (as well as Africa and Asia), have been compelled to draw down these reserves to cover their gaping fiscal deficits.
I am seeing figures that reveal that the Saudi Arabian Monetary Agency (the kingdom's investment arm) has withdrawn something in the order of $70-billion from external managers in just the past six months to meet its social spending requirements.
Qatar, Kazakhstan and Norway all are in similar predicaments – Norway (the largest sovereign wealth fund in the world) reportedly has shed $1.1-billion of its equity holdings ($58.5-billion in total) and Abu Dhabi has cut $300-million from its $3.6-billion exposure to U.S. equities.
So you see, the stock market is telling us nothing at all about the economic outlook; rather, the sudden sell-off in the past two months represented one giant margin call as the petrodollars that were deployed into equities during the good times are now being reversed.
Pressures have been building for far too long on the oil-reliant governments around the world to draw down their sovereign wealth fund assets to finance their budgetary shortfalls and support their fledgling economies.
This is the story, and at some point maybe the more effective strategy will simply be to stop overproducing the crude – all the Organization of Petroleum Exporting Countries has to do is revert to its old quota and voilà, the supply glut will be ameliorated and oil will very quickly leap toward $50 a barrel.
But that obscures the overriding point here, which is that the equity market decline is really telling us more about the run-off at sovereign wealth funds than anything nefarious about the economy, especially the U.S. economy (which at last look was still a net oil importer so, accruing all the losses and gains, the United States still comes out a winner, even if some patience is required).
David Rosenberg is chief economist and strategist with Gluskin Sheff + Associates Inc. and author of the daily economic newsletter Breakfast with Dave. For a two-week trial to the newsletter, click here and use promo code "Globe"
David Rosenberg