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Schork Oil Outlook: Chinese Demand = Inverse Correlation

Yesterday, the Chinese government announced its third interest rate hike since October. The rate on the 1-year lending rate from the Bank of China will increase 25 bps to 6.06%. Next Monday, China reports on wholesale and retail inflation. Expectations are a 50 bps increase in the former, to 6½% and a 70 bps increase in the latter to 5.3%.

As with the prior two rate increases, the intent is to deflate an overheated real estate market. More importantly, as far as we are concerned, short odds suggest the latest move by the Bank of China will also deflate the oil market.

Since the start of the last decade there has been a strong relationship between oil and the pace of inflation in China with both paths shifting almost in tandem. As China continues to grow, analysts at The Schork Reportadvise that so too shall this correlation.

Bottom line, attempts made by the Chinese government to cool demand, should give pause to the bull’s cause.

In this vein, the collapse of the front end of the Nymex WTI forward curve should also be generating some agita for bulls. Over the last month the 1st/2nd month spread jumped by 244 bps to 3.8% or -$3.30 a barrel as of last night. What’s more, the contango between the spot March contract and December settled at -$11.25 or 13.4%. Assuming cost of $1.25 a month, the current spread is enough to carry inventory through the end of 2011.

So you have to ask yourself… if the fundamentals were really that bullish, would the market (even the Nymex) allow you to do that?


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.