I don’t want to be an alarmist but if oil prices are still below $60 a year from now, could history repeat itself during the next 18 months? Back in 1997-1998, the price of oil fell 60%, the US dollar surged 40% and Russia defaulted on its debt. A repeat experience would likely deliver a deadlier result to financial markets, as authorities have already pulled out all the stops in their attempts to fight the structural headwinds of high debt and unfavourable demographics. Determining the likelihood of this happening is virtually impossible since words from the powers of OPEC members in the Middle East have so far suggested they’re willing to use their balance sheets to maintain this game of attrition for as long as it takes. The negative scenario would create significant challenges to Canada’s housing market and economy in 2016, creating further downside in many staples of Canada’s financial markets.
On the flip side, if we finally see production shut-ins versus mere deferments of capital spend, and the Saudis assuage to the pressure of their cash starved peers, cut supply and allow the oil quote to breathe into the mid-$60 range, then asset markets could look very different by the Fall. Yields on developed country sovereign long bonds will have reversed a portion of their year-to-date 60 basis point (bps) move, sector rotation will be the flavour of the day in equities, and the Canadian dollar will have gained back several pennies of its 8.5% January plunge against the US dollar. It’s this degree of uncertainty that explains the attractiveness of low volatility, long/short equity funds...