Must Read---Economy

I don't always share articles, but this article by Ben Tal of CIBC puts things into perspective.

With everything that's going around regarding oil and over valuation of real estate, there is a lot of negative press out there, and I thought I'd share this write up to help address some of your clients' concerns.

By Benjamin Tal

The rapid decline in oil prices is a surprise. While in recent communications we argued that the super-cycle in commodities is dead and energy prices might ease, we did not expect such a dramatic drop in prices. The key question is to what extent the oil market is overshooting. First, we have to establish the fact that, as opposed to previous price declines, this time the catalyst is a supply shock as opposed to a demand shock. Therefore any reference to the past as a guide is not very useful. There is little doubt that what’s behind OPEC’s decision not to cut production is its desire to “test” the response function of shale-oil in the US. That is, to see how quickly shale-oil operations slow production when faced with low prices. Judging from recent announcements from the shale-oil sector and oil sands in Canada, clearly this response function is very quick. We are already seeing a notable downscaling of future projects. Note that OPEC did not lose market share globally, but it did lose market share in North America. This process is not only to regain some lost market share in the region but also to see how quickly they can do it in the future.

So what’s next? There is absolutely no way of predicting where oil prices go in the coming weeks. There is clearly negative momentum in the market, and it seems that OPEC is in no rush to meet again anytime soon despite the fact that some of its members (Venezuela, Iran) push for such a meeting. At this point, a reasonable working assumption is that prices will go back in the coming 6-12 months to around $70/bbl and might stabilize at around $75/bbl. Such a scenario will keep most players relatively happy. While Canadian stock markets reacted negatively to the drop in oil prices, the reality is that from a global perspective, lower oil prices is a net positive. For the US, despite the negative impact on its energy sector, the drop in oil prices might boost GDP growth by close to 0.5% next year. At this point, it seems that the Fed is willing to test the waters and start hiking rates, say in mid-2015. However, the fact that lower oil prices is a net negative for the Canadian economy might allow the Bank of Canada to wait even longer. Accordingly, it is possible that the Bank will not move until late in 2015.

Talking about the Bank of Canada, we are a bit puzzled by its recent communication regarding the housing market. First, the Bank released a study suggesting that house prices are 10%-30% overvalued. The study compares Canada to many other countries, and given the need to keep data consistency, this means that, by definition, the model they used cannot be robust. In fact, the model does not take into account that in places like Toronto and Vancouver, supply is limited due to land restrictions and geographical factors. This is not to judge how accurate the model is; we are simply puzzled by the need to release such a study, knowing that the media will automatically focus on the 30% figure. In the same communication, the Bank suggested that we are seeing a notable increase in the share of mortgage lending provided by secondary lenders. While it is absolutely true, all the discussion was on the rate of growth as opposed to the actual and relative size of that market which is roughly 2% of the total market.

Sherry Boyal

Sherry Boyal

CENTURY 21 Coastal Realty Ltd.
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