Crude Oil And Energy Stocks: It's Not The Cold Weather, It's The Business Cycle

Summary

  • Cold weather causes price volatility in crude oil.
  • The inventory cycle, as expected, is fueling a strong business cycle.
  • Crude oil has been rising since the business cycle signaled solid economic growth.

My article “A Strong Economy And Easier Lending Standards Are Fueling The Bull Market” published on February 16, 2021, reviewed data showing the economy is strong and will stay strong.

The main theme of the article was the fact business decisions cause business cycles to rise and fall. The most important of these decisions is the management of inventory levels to meet changes in demand. When sales grow faster than inventories, business is forced to increase production to replenish them in order not to lose sales.

To do so they must buy raw materials – thus placing upward pressure on commodity prices. They must hire more people in manufacturing – thus causing employment and wages to improve. They must borrow more to finance working capital and make improvements to the manufacturing process – thus placing upward pressure on interest rates.

The business cycle starts to slow down because of slower demand. Business is eventually forced to reduce production to avoid unnecessary and costly inventory accumulation. They will reduce purchases of raw materials – thus placing downward pressure on commodity prices. They will reduce the workforce to cut costs – thus causing unemployment to rise and wages to grow more slowly. They will borrow less to finance and improve their operations – thus placing downward pressure on interest rates.

The important trend – as reviewed in the above article – was a visible decline in the inventory to sales ratio caused by sales rising faster than inventories. As suggested in the article, business had to increase production to replenish inventories due to strong sales.

On 2/17, following the publication of my article, the Fed released the latest data on industrial production. It showed industrial production rose a sharp 0.9% m/m. The above chart shows the continued improvement in production as expected in the article. Business must keep producing aggressively to replenish inventories.

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Disclosure: I am long XOM, MPC.

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