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Schork Oil Outlook: Even China Has Limits

Friday, 21 Jan 2011 | 2:55 PM ET

A funny thing happened on the way to $100 oil...

Nymex crude oil tanked yesterday, falling at one point by more than 4% off of Wednesday’s high print. Bears were apparently spooked by the latest inflation figures out of China, which showed another strong rise on both the wholesale and retail side of the economy.

The bear’s concerns are not unwarranted. As we noted in recent months, there is a strong relationship between the pace of inflation in China and the value of oil. In today’s issue of The Schork Report, we graph the change in Nymex WTI prices against the YoY increase in the Chinese Consumer Price Index.

The eyeball test shows strong correlation at the start of 2009, with Chinese inflation and the YoY change in WTI turning from negative to positive territory almost in tandem (YoY WTI entered positive territory in October 2009, inflation followed in November 2009).

However, the numbers are even starker. Of the last twelve months, the CPI and WTI have seen the YoY move in the same direction every single month, either falling in tandem or rising in tandem. This is not a recent trend. The government in Beijing has raised borrowing costs twice since October in an attempt to cool demand growth, yet over that same time not only has inflation risen, but the ratio between producer and consumer prices has increased from 1.136 to 1.283, an indication that producers are unable to pass along costs.

Bottom line, even China has its limits…and maybe one of these days Wall Street will get the memo. In between November and December the amount of length in Nymex crude oil sitting on the books of managed money accounts ballooned by one-third to a record 202,221 contracts, i.e., more than 5× the supply of crude oil in tank at the Nymex hub in Oklahoma.

Through the first two weeks of this year that position fell by 13%, only to then rise by 11%. As such, Wall Street just cannot help itself. The investor class is determined to own this market… for better or for worse.

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Stephen Schork is the Editor of The Schork Reportand has more than 17 years experience in physical commodity and derivatives trading, risk systems modeling and structured commodity finance.

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