Eric Sprott Was Right — Oil Slump Says ‘No’ To Recovery Story

February 26, 2015

Gas prices are some of the highest in the country in San Diego, California, and it still cost me only $2.96 a gallon to fill up my tank last week.

There’s an excess of oil supplies, according to analysts. You can see from the chart below that global oil production has been rising steadily over the last three years.

Global Crude Production

In our new report, we make the case that the oil decline is not merely a supply issue.

Oil is cheap, but so are copper, uranium, iron ore – all the materials that are used in a growing economy. Increased production of goods and services tends to stimulate consumption of these raw materials.

This recovery isn’t causing an uptick in demand for these metals and energy sources. Hence, copper is near a four-and-a-half year low of $2.661 per pound. Uranium is at $39 per pound, down from $652 per pound in 2011. Iron ore for delivery in 2015 trades below $60 per tonne, down from over $180 per tonne in 2011.

Instead, we are seeing an uptick in the demand for US stocks, bonds, real-estate, and other assets whose values have been rising.

US stocks have soared by around 100% since early 2011. Corporate buybacks and debt issuances have surged too. US corporations are piling on new debt and buying back their shares. In 2014, S&P500 companies are estimated to have spent 95% of profits on buy-backs and investor payouts.

As you can see, stock buybacks have been on the rise since the crisis.

Buybacks S&P500

These buybacks are in part fueled by historically low interest rates, allowing companies to borrow cheaply. Around $1.7 trillion in buybacks occurred from 2011 to 2014.  New corporate debt has increased by around $1.4 trillion during that time – as you can see in the chart below.

Corporate Debt

Sustained low interest rates have also boosted the bond market and helped the housing market where the availability of financing for purchases is crucial.

US stocks, bonds, and other assets are getting a lift from low interest rates… We have even seen some jobs growth in the last year. This has fueled an optimistic ‘recovery’ story.

A prevailing narrative is that the US economy is recovering, while other major consumers of raw materials like China and Europe are not. Thus commodities are cheap despite a recovery in the US.

Proponents of this thesis look at higher assets prices brought on by ultra-low interest rates as signs of economic growth. Yet the low interest rates that are driving these price increases are symptoms of a tepid economy. Debt is cheap because investors expect weak inflation, or even deflation, and are rushing to safety.

Eric Sprott wrote in his September note:

While most have been conveniently blaming the tepid first quarter -2.9% GDP growth figure on the weather, we believe it is just another symptom of a much deeper malaise. […] The U.S. economy has been on life support, graciously provided by Central Planners.

[…] The bottom 40% of households still rely heavily on government assistance, have had stagnant incomes and have been faced with increasing inflation for ‘non-discretionary’ goods that constitute a very large share of their incomes.

There clearly is no recovery…

Cheaper oil prices don’t just come ‘out of the blue.’ Other commodities used for raw materials, construction, and economic growth, have been languishing too. And real median incomes remain stagnant since the Great Recession.

These are all signs that the recovery we are seeing is mainly asset inflation brought on by cheap debt, not economic growth.

You can download our full analysis in our new report ‘Oil and Gold: Where Do We Go from Here?’ Click here.

During 1500s the Spaniards had taken 16,000,000 kilograms of silver from Peru.