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What’s up guys!
What a difference a few days makes.
Oil below zero, who woulda thought.
Certainly I’ve never encountered nor learnt about this in the textbooks.
You see, over the weekend the price of oil dropped down to -$37.50.
Which meant if you wanted a barrel of oil, the seller would gift it to you, AND pay you $37.50 for the privilege.
The reason is because of COVID-19, or rather the lack of global consumption as a result of the lockdowns from COVID-19.
But how can the price of something be negative?
Well, in short – the price of oil is actually a futures contract, which is an agreement to buy or sell a commodity (oil in this case), at a predetermined price in the future.
As oil is a physical commodity, the buyer needs to take delivery of the physical oil at the expiration of the contract.
And because no one is consuming oil these days, suddenly you have a major supply problem, as storage facilities around the world are already full to over-flowing.
Hence, no one wanted to take physical ownership of oil, and why people would pay you (the buyer) to take it off them (storing it is now your problem).
That’s the state of play of the global economy these days.
Virgin, no more…
And closer to Oz, we’ve just had the first major casualty of big business with the collapse of Virgin Australia into voluntary administration (self-imposed bankruptcy).
I don’t think there’s enough emphasis on how this will affect the Australian economic landscape going forward.
Because Virgin was drowning in something like $5 billion in debt, most were owed to foreign lenders, but around 25% are to local lenders.
That’s still over $1 billion in lending which needs to be restructured in one form or another by their primary bankers (big 4).
This means more capital provisions need to be held by the banks (capital provision are funds set aside to pay for anticipated losses).
Which means less money is made available to lend.
Which means less credit in the economy.
Which means less growth ahead.
Of course, Virgin was in trouble for a long time before this.
Their profit margins were skinny and expenses were heavy during the best of times – an argument could be made that the banks were ready.
But what if another big name topples over?
The longer this drags on, the more likely another will.
Then we’ll see more risk aversion from the banks, as the financial system itself comes under pressure.
Curiously, the ASX barely moved in the last couple of days despite the oil shock and Virgin collapse.
Personally, I don’t know what to make of this.
Is the market ignoring these stories as non-events? Or has there been so much negativity factored in that only true armageddon will drop the markets from here?
I’m not convinced, I think there’s more to this story still to play out.
It’s also a major reason why I haven’t committed more capital to the stock market.
The economy is an inter-connected and complex web, built from real and imaginary financial products.
When one piece falls out of place, that has an effect on the other pieces.
Methinks it’s time to load up on more cash, because there’s another change on the wind.
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