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0 Feb 24 2011 @ 7:54am by Matt Smith in Capital Markets, Crude Oil, Economy, Global Energy, risk management

Pops and Drops

The title of this post would have been much funnier (maybe) if I had actually appeared on CNBC’s (Pop ‘n Droptastic) Fast Money as I was going to – but instead I was on Power Lunch (which although great, makes this title just a little less appropriate). But does this dissuade me? Heck, no – I am pushing on through regardless to illustrate some pops and drops that have been served up by financial markets in the last few days. The turmoil in MENA* ( = Middle Eastern and North Africa) has flipped markets around like a pancake – some have headed ceiling-bound and stuck, and some have crumbled in a pile on the floor. Here are some examples of both.

So first up; the most relevant and most headline-grabbing. The pop in WTI crude oil:

WTI Daily Chart, April 2010 - present

WTI crude oil has reached the $100 mark for the first time since September 2008, as the escalation of unrest in Libya (and the risk of contagion to other oil-rich countries such as Algeria, Iran and Saudi Arabia) has set about building a large risk premium into prices should supply be materially affected. Until resolution is seen in the Middle East, this worry premium will not unwind in any substantial way.

Next up, we take a look at one of the victims of the phenomenon ‘in times of crises, all assets correlate’. Hence, Tuesday saw wheat prices end limit down (the maximum amount a contract may decline in one trading day) as a flight from risk took place across asset classes. Despite seemingly supportive fundamentals in place for wheat (and a bullish trend – see chart below), prices fell in unison with commodities (barring the crude complex) as traders liquidated speculative positions and fled to the sidelines:

Wheat Prompt Month, July 2010 - present

Finally, let’s look at the best proxy for risk appetite; equities, and specifically the technology stock-laden NASDAQ composite. One of the greatest market commentators in the world today is Mohamed El-Erian, who is the CEO / co-CIO of Pimco (the world’s largest fixed income money manager). He raised the following insightful point this week about the trouble in the Middle East, a succinct summary I felt – ‘When the crisis and turmoil started to hit Libya and Bahrain, this whole phenomenon has morphed. And it has morphed into something that in the short term means higher oil prices, greater risk aversion, and a somewhat flight to quality.’

As the below chart illustrates, the Nasdaq composite hit a three-year high on Monday, rallying on improving global economic prospects until the latest developments in MENA has sucker punched the index in the guts. Its lack of exposure to energy stocks (one of the few beneficiaries of the recent rise in crude) and its generally racier make-up has exacerbated the selling we have seen in other stock indices:  

NASDAQ Composite, 2007 - Present

As worries persist, it looks as if these large moves will continue as volatility remains; financial markets hate uncertainty after all. As one of the Paul Farrell’s 10 famous market rules states:  ‘…rapidly rising or falling markets usually go further than you think…’. Buckle your seatbelts, it looks like we are in for further turbulence.

*The energyburrito acronym of the week

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