How a Slowing Economy Speeds the Oil Run-Up

Now, everyone's getting on the stagflation bandwagon. Or, to be more exact, they're saying that the economic slowdown and even higher oil prices may go hand in hand, as we pointed out has happened in the past.

From oil industry consultant Daniel Yergin, chairman of Cambridge Energy Research Associates: "Oil has become the 'new gold'—a financial asset in which investors seek refuge as inflation rises and the dollar weakens. The credit crisis has been fueling the flight to oil and other commodities, and that will last until the dollar strengthens or the recession becomes more pronounced."

From Larry Chorn, chief economist for Platts Research and Analytics Group: "Our expectations are for a rapid return to the recent price levels and a resumption of the rise in crude oil prices, directly linked to the erosion of the U.S. dollar relative to other currencies. Subsequently, non-commercial participants will return to the market and further propel prices upward as they seek an inflation hedge and a currency play. With [Tuesday's] 75-basis-point reduction in key short-term interest rates, the Fed continues its eight-month trend of loosening credit which will, in turn, continue the downtrend in the value of the dollar. If recent history is a guide, the 75-basis-point rate reduction by the Fed could result in oil prices rising to the $112 to $115 range over the course of the next weeks."

And JPMorgan Chase's just-released Oil and Gas Monthly analysis notes that it has for sometime had a "somewhat contrarian view that a recession or economic slowdown could actually be bullish for commodities," based on investors fleeing to commodities like oil as an inflation hedge. The investment bank's analysts calculated the institutional investor inflows using Commodity Futures Trading Commission data and estimated that there is now $181 billion invested in commodities through index funds and other products, up 45 percent over the same time period one year ago and 83 percent over 2006. "Ongoing dollar weakness, the equities slump, and a near guarantee of at least one more rate cut should continue to encourage commodity inflows," the analysis said.