- Oil and US equities now strongly correlated
- Iran an emerging oil market issue
- Suggests higher prices given tight fundamentals
- US production growth may become more consistent

By Chris Shaw

According to US Energy Information Administration (EIA) figures, crude oil and the S&P500 Index have had a close positive correlation in 12 of the past 13 quarters. This follows not one single quarter of similar positive correlation in the previous 35 quarters.

For US Global Investors, the current correlation suggests equity prices have the potential to move higher if oil prices continue along their currently positive trajectory. As US Global Investors CEO and chief investment officer Frank Holmes notes, West Texas Intermediate Prices have risen by about 28% since early October.

Holmes sees scope for further oil price upside, in part due to current supply and demand fundamentals in the market. On the demand side, Holmes notes the turmoil in Europe and a slowing in the Chinese economy has had little impact.

EIA figures support this, as by the end of 2012 the group is forecasting world crude oil and liquid fuel consumption of nearly 90 million barrels per day. Expectations are for global demand to move beyond 110 million barrels per day by 2025.

Holmes suggests the emerging market transportation sector is a major driver of this increase, with International Energy Agency (IEA) figures suggesting the total number of passenger cars in the world will almost double to 1.7 billion by 2035.

On the supply side constraints continue to impact, with US crude oil inventories now at the lowest seasonal level for seven years, observes BA Merrill Lynch. Geopolitical unrest is also an ongoing issue, with Iran now a major contributor to such unrest on suspicions of nuclear proliferation.

Barclays Capital has also picked up on this, noting the International Atomic Energy Agency has released a report indicating an increase in concerns about possible undisclosed Iranian nuclear activities. The report has come at a time when US-Iranian relations are already strained, as the White House is expected to push for tougher economic sanctions against Iran.

The reports of Iranian nuclear activity have some in the market speculating on a possible Israeli strike, though Barclays takes the view a regional war involving Iran is a low risk at present.

The issue for the oil market would be the potential for any closure of the Strait of Hormuz, as this is the sole waterway leading out of the Arabian Gulf. Barclays expects the US military would be able to keep this Strait open, but there would still be a question as to whether Iran could impede shipping enough to impact on supply from the region.

Barclays suggests any market fears of such a disruption to traffic could boost market sentiment and so support oil prices, especially given current fundamentals are tight. Holmes agrees, seeing potential for the market to be concerned about any possible loss of shipments through the Strait, which accounts for 18 million barrels per day.