Investors Flock to Crude Oil as Inflation Hedge Amid Trade Tensions
As trade tensions escalate, investors are increasingly turning to crude oil futures as a safeguard against the risk of rising global inflation. This surge in demand has contributed to a recent rally in oil prices, sparked by tightened sanctions on Russia.
Oil: A Popular Inflation Hedge
Oil is a favored inflation hedge due to its significant presence in Consumer Price Index (CPI) baskets and its indirect impact on goods and services costs. However, this widespread adoption of oil as an inflation hedge could ultimately drive consumer prices higher.
Fund Managers Bet Big on Oil
According to data from the Commodity Futures Trading Commission, fund managers have built up the largest net long position in crude oil futures in nine months. Francesco Sandrini, head of multi-asset strategies at Amundi, Europe’s largest asset manager, believes oil is the best hedge against inflation, particularly if U.S. inflation proves more resilient than expected.
Commodities Defy Expectations
In a surprising turn of events, prices of oil and other commodities considered higher-risk investments have risen despite a stronger U.S. dollar, which typically makes them more expensive for holders of other currencies. Brent crude and U.S. WTI futures prices have climbed around 5% and 4%, respectively, this year, recently trading at six-month highs.
Inflation Fears on the Rise
Investors are concerned that threatened tariffs on countries like Mexico, Canada, and China could lead to higher inflation, despite the new president’s vow to lower consumer prices. Money managers’ net long position in a basket of commodities has risen close to a three-year high, with crude contracts drawing the most demand.
Energy: A Strong Inflation-Adjusted Performer
Historically, energy has provided the strongest inflation-adjusted returns when consumer prices have risen faster than expected. Energy forms a significant portion of the U.S. consumer price index (CPI) and the euro zone equivalent, making it an attractive hedge against inflation.
The Vicious Circle of Inflation Hedging
However, some experts warn that inflation hedging can create a self-reinforcing cycle. Ilia Bouchouev, former president of hedge fund Koch Global Partners, notes that investors buying oil futures to hedge against rising consumer prices can push oil prices higher, fueling more inflation and more hedging trades.
Sticky Inflation and Market Expectations
Recent economic data, such as the U.S. jobs report, has fanned inflation fears, with consumers’ price expectations rising over both the short- and medium-term. As a result, markets are now expecting the Fed to be more cautious, and higher oil prices are seen as a negative for the inflation outlook.
Commodities: A Good Diversifier, Up to a Point
While commodities are considered a good diversifier, they can still be affected by growth concerns. John Roe, head of multi-asset at Legal & General Investment Management, notes that if inflation scares lead to growth concerns, commodities can get caught up in the downturn.
Momentum Trading Funds Join the Fray
The oil market rally has also attracted momentum trading funds, according to Saxo Bank’s analysis. Additionally, commodity trading advisors (CTAs) are flipping their positions, helping to further boost prices.
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