Commentary: Usual fundamentals don’t fully apply By Myra P. Saefong, MarketWatch TOKYO (MarketWatch) — In a world where investors suffer from quantitative easing jitters, global economic uncertainty and a weaker U.S. dollar, oil’s traditional fundamental factors of supply and demand don’t fully apply. Instead, traders have been struggling with a different trading environment for oil, and analysts warn that the new terrain will translate into more price volatility. Lately, it’s been a guessing game when it comes to deciding how each factor will influence trading. It’s “all new to the traders, and they are experimenting to try to find formulas that will help them predict the impact on oil prices,” said Charles Perry, president of energy-consulting firm Perry Management. The market will see a lot of volatility until other factors, such as the more usual geopolitical issues and supply and demand levels, become more pronounced, he said. Year to date, crude futures prices appear to have moved very little, but they’ve actually made some subtle changes. The front-month February contract on the last trading day in December 2009 ended at about $79 per barrel on the New York Mercantile Exchange, little changed when compared with December crude’s close near $82 on Thursday. Read the latest Futures Movers column. But prices are up about 16% since the low of around $71 seen in late August. “Very little of the recent price rise has really been down to the improving supply-demand balance,” said Matt Parry, senior oil consultant at KBC Process Technology Ltd. Instead, most of the recent rise is due “to a combination of the anticipated renewal in quantitative easing and the general increase in investor appetite for risk.” In fact, investors could discover that they’ve bitten off more than they can chew when it comes to increasing their risk. “Any market that shows a strong divergence from its fundamentals … is vulnerable to a sharp sell-off,” said Darin Newsom, senior analyst at Telvent DTN. Commodity overhaul Still, there’s no denying that the trading backdrop for commodities has become one in which the asset class serves as a refuge for investors, and oil’s no different. “Commodities seem to spend more time moving with little regard to underlying fundamentals,” said Newsom. “Money flows from market to market, often driven by action in the dollar.” Weakness in the dollar against its foreign currency rivals, money flow in financial markets, and worries over further quantitative easing have all been strong influences in gold’s climb to record levels, but they’ve been key factors for oil as well. “The extreme liquidity in financial markets recently has caused some commodities (like gold and oil) to inflate far more than fundamentals would support,” said Michael Lynch, president of Strategic Energy & Economic Research. “Expectations of the [second round of quantitative easing] and then the reality were the major factor behind oil’s rise since September, with secondary support from slight strength in fundamentals,” he said. The U.S. Federal Reserve said on Nov. 3 that it would buy $600 billion in Treasurys over the next eight months. Read a story on QE2’s risk to the world economy. Investors fear that increased money supply from quantitative easing will “ultimately weaken the U.S. dollar, sparking increased buying in commodities, including crude oil,” said Newsom. “This could lead to a larger divergence between market trend and market fundamentals.” Those concerns helped feed volatility. Oil prices have lost more than 6% since Veteran’s Day.

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