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Oil’s Disaster: What Can Investors Expect?

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Nov. 20 2020, Updated 5:11 p.m. ET

Oil and yield spread

On December 20, the US 10-Year Treasury Constant Maturity Minus 3-Month Treasury Constant Maturity yield spread was at ~40 basis points—just two basis points above the lowest level since September 2007 on December 19. Investors’ demand for a longer-dated security than a shorter-dated security might be one of the reasons behind the contraction in the spread.

In the last three decades, when the yield spread turned negative, a recession started the next year. Another contraction in the yield spread might increase the concerns about oil’s demand. Oil is a growth-driven asset, which is another problem for oil prices. China might completely stop or significantly reduce its oil imports from the US in January based on a Reuters report. In fact, China’s oil imports from the US might fall to zero. A decline in China’s oil imports might put pressure on the US or WTI crude oil’s performance compared to Brent crude oil prices. China’s lower oil imports could hurt US  oil exports in the long term. China’s lower imports could be a problem for the US and China trade war truce. On the supply side, oil bears should watch the magnitude of OPEC’s cut in 2019.

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Oil prices

On December 20, US crude oil February futures fell 4.8% and settled at $45.88 per barrel—the smallest closing level for active US crude oil futures since July 21, 2017. In the trailing week, US crude oil prices lost 13.2%. The Energy Select Sector SPDR ETF (XLE) fell 2.8% on December 20. The S&P 500 Index (SPY) and the Dow Jones Industrial Average Index (DIA) fell 1.6% and 2%, respectively. The sharp fall in oil prices could be because of the fall in equity indexes. In Part 3 of this series, we’ll analyze US crude oil’s relationship with these equity indexes. Integrated energy stocks like ExxonMobil (XOM) and Chevron (CVX) are also sensitive to oil prices.

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