The Slippery Effects of Oil on our Economy

The NorthAmerican stock markets have shown tremendous resiliency in the past month! Notonly have the indices stabilized in the face of a slowing economy, but theyhave also actually rebounded quite dramatically off their lows. The TSX isflirting for the first time this year with positive returns.

 

 

The North
American stock markets have shown tremendous resiliency in the past month! Not
only have the indices stabilized in the face of a slowing economy, but they
have also actually rebounded quite dramatically off their lows. The TSX is
flirting for the first time this year with positive returns.

 

 

If we have
already seen the low point for the indices this year, and the markets begin to
rise, how long will this rally last? What economic issues are on the horizon
that have yet to be dealt with that could curtail this rally?

Most of the
attention of the central banks in Canada
and in the U.S.
has been focused on the credit crunch and the health of the banking system.
However, as the year moves ahead and the credit fears of today subside, it will
be the high price of oil and its effects that will occupy our governments’
thoughts and actions.

Today the
price of oil sits at an all-time high. Oil is purchased and sold in U.S. dollars.
Therefore as the greenback continues to fall in comparison to other countries,
these countries with the stronger currency are able to purchase more oil at a
lesser cost to them. This in turn drives up the price of the much needed
commodity further.

At these
high prices, oil begins to act as an extra tax on the consumer. If you are
paying more at he pumps, you will have less money to spend elsewhere. Therefore
if the consumer has been the main force driving the North American economy,
this will have a devastating affect.

As the
price of oil continues to rise, so does the cost of everything around us. The
high price of oil affects many aspects of life such as the way we conduct
business, tourism and food consumption. It creates inflationary (the increase
in cost of goods and services) pressures! As companies budget for their day to
day business, they now have to factor in higher shipping costs to send goods to
their customers. Families may now only take one holiday a year versus two or
three due to the higher costs of filling up their gas tanks. Finally, as we
seek out other forms of energy (ethanol), we exhaust our supply of food items
such as corn to create alternative energy. This in turn drives up the cost of
food purchases.

Some
economists have begun to use the term “stagflation” (environment with no growth
and higher inflation) to describe the economic environment in North
America. If this is the case, the continuous lowering of interest
rates will only increase inflation further. Conversely, if the Central Banks
were to increase interest rates, inflation would be deterred but our economy
would slow down going forward.

At this
point the governments in the United States
and Canada
do not see inflation as the major problem. They are hoping that the price of
oil will fall as the year moves forward and the economy will get stronger.
Therefore reducing inflationary pressures! Until such time, the strong Canadian
dollar will continue to act as a buffer to inflation by allowing Canadians to
purchase oil at a lesser cost even with oil prices at record highs.

As an
investor today, it is important to make sure you have investments in your
portfolio to combat the effects of inflation. Ask your advisor if your
portfolio is prepared for this type of scenario. What will you do if inflation
becomes a problem later in 2008?

If you have
any questions on the effects of high oil or inflation on your portfolio, send
me an email at asmall@dundeesecurities.com.


Allan Small is an
Investment Advisor with Dundee Securities Corporation, a DundeeWealth Inc.
Company. This is not an official publication of Dundee Securities and the
author is not a Dundee Securities analyst. The views expressed are those of the
author alone, and are not necessarily those of Dundee Securities.

 
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