India not an island

Low oil and metals prices will lead to lower growth and market correction

Please refer to my blog dtd 17^th Dec, 2014 titled “Low crude and gold price can’t sustain Indian stock market rally” where in I had argued that “Too much of anything” is bad which applies to very high as well as very low prices of oil and commodities and also to inflation.

India is not an island and is bound to be impacted by China’s slowdown and geo political tensions in Middle East. The prices of oil and metals are impacted by the change in world trade dynamics in last one year. China’s surprising sharp slowdown in growth and demand but continuing huge production capacities built up over last decade in the anticipation that China’s high growth will continue forever continue to keep metal prices under pressure. Technological advances leading to the increased cost efficiencies in renewable energy sources like solar, and wind power have put the renewable energy almost at par with the conventional energy sources like oil, coal, etc. As such demand for conventional sources of energy like oil, gas and coal has also come under pressure. The fight to retain market share is keeping the oil production at record high despite demand slowdown. Oil prices are also expected to come under further pressure with the imminent threat of additional oil supply from Iran as it comes out of sanctions. Strong US Dollar will continue to keep oil and metals prices under pressure.

Lower prices lead to lower GDP growth at market price as absolute earnings decline since volume growth can’t compensate the stiff price fall. This further deters industries and corporates from investment as lower prices reduces ROI (Return on Investment) which in turn puts pressure on GDP.

I have put a chart below which shows BSE (Bombay stock exchange) SENSEX movement versus Brent crude oil price.

The chart can be divided into 3 periods of 2004-2010, 2011-2014 and from 2015. There exists a correlation coefficient(r) of +0.7 between crude oil price and BSE SENSEX movement barring brief period of 2011-2014. This indicates strong positive linear relationship between crude oil price and BSE SENSEX movement which means that BSE SENSEX moves in tandem with crude oil price.