Will a flattening of the yield curve on U.S. Treasurys give a boost to oil prices? In some respects, it already has.
The Fed’s decision to hold the front end of the curve at near zero for at least the next two years will undoubtedly push cash off of the sidelines. For instance, at the end of the second quarter Apple had $76.2 billion of cash on its balance sheet (cash + marketable securities). For comparison's sake, as of last Friday Uncle Sam had only $24.6 billion (Daily Treasury Statement — Total Operating Balance) on hand.
The Fed has essentially turned a two-year T-note into a T-bill. Last Friday, two-year Treasurys yielded 0.19%. At the end of the second quarter these notes yielded 0.46%, a decline of 27 bps in six weeks. Therefore, there is a ton (figuratively and literally) of money out there that is not earning anything.
Bottom line, the Fed is shoving capital towards higher risk asset classes which not only include equities, but also hard assets such as gold and oil.
Last Friday the dollar bought 1/1740th of an ounce of gold. In turn, an ounce of gold purchased 20.4 barrels of oil (Nymex).
Over the last 35 years the relationship between oil and gold prices averaged 15.1 barrels per ounce of gold.
In this respect, spot gold averaged over $1,744 an ounce last week. At this value a reversion to the historical mean on oil translates into around $115 a barrel on the Nymex; which is right near the highs we saw in the spring.
As written in today’s issue of The Schork Report, it is therefore not unreasonable for Nymex crude oil to test the $115 barrier before this year is out.
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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.