Oil — Just the Catalyst We Need for New Wealth Creation

by Mitchell Clark, B. Comm.

If you take a look at a five-year chart of one of my favorite exchange-traded funds (ETFs), the iShares FTSE/Xinhua China 25 Index (NYSE/FXI), you’ll notice how dramatic the recovery in China stocks has been just since the beginning of the year.

FXI set a record high around $70.00 a share (post split) in October 2007. As the Chinese equity market was in a bubble, those stocks fell during a much-deserved correction. Then the global financial crisis hit and these stocks dropped even more dramatically. The current value of this basket of stocks is around $43.00 a share, which is about the same value just before the subprime mortgage collapse got started.

In my view, Chinese equities are very well positioned for further capital gains. As a group, I think large-cap Chinese stocks will keep ticking higher in value over the coming quarters because of that country’s stimulus spending and the economy’s substantial organic growth.

Advertisement

If Chinese industry and infrastructure do well, then the rest of the world has a problem. In the current recession, the price of a barrel of oil is trading just over $70.00. China isn’t growing as much as it was, but it’s still growing much faster than Western economies. So, if the global economy recovers only slightly, and China ticks along as usual, I don’t see how the price of a barrel of oil won’t easily gravitate to the $100.00 level. This creates a more difficult environment for economic recovery at home.

The reason why China has been economically successful over the last several decades (politics aside) is that it has become the world’s factory. And the reason why China has become the world’s factory for a lot of goods we use on a daily basis is a cheap pool of labor and cheap oil. As odd as it is, it’s now cheaper to send raw materials from the United States to China, have those materials processed and packaged, then sent back to the U.S. in the form of a finished product to consume. We know that China’s cheap labor pool will continue to exist for decades, because hundreds of millions of rural people want to work in factories so they can earn more money. So, the only variable left to thwart this “globalization” is the price of oil.

China and India are in a position now where their economies are beginning to feed on themselves. Over time, those two burgeoning economies won’t need the rest of the world as they once did. So, if their demand for oil increases enough to bring the price of a barrel to over $100.00, then the rest of the world will have a more difficult time, while those two developing economies do well.

I suppose the only constant going forward is that there is going to be a lot of change coming in the global economy. The only way we can outperform is if we turn the tables and manufacture goods at home that we can sell to China. The industry that stands out where we can lead is alternative energy. Innovation in alternative energy and the green economy is the only way we can achieve substantial new wealth creation over the coming decades. It’s likely that the price of a barrel of oil won’t let us consider any other option.