Currency Corner: Indian stock markets should retain uptrend despite Iraq oil crisis

Jul 22 2014, 10:50 IST
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Militant insurgency and violence in Iraq have put the brakes on the great Indian stock markets rally. Investors are weighing in the potential impact of higher energy prices as the possibility of a supply disruption from the world's sixth biggest oil exporter is priced in global oil benchmarks. Both WTI crude and Brent crude are trading at 10 month highs with the spread between these two benchmarks having widened to $7 per barrel. India is the world's fourth largest importer of oil and imports nearly 75 percent of its demand.

Looking at the daily candlestick charts of the Western Texas Intermediate (WTI) June futures contract, we can already see that the market price is factoring in a risk premium for the Iraq geopolitical risks. The Relative Strength Index (RSI), which shows how strongly a future price is moving in its current direction, is currently 70, a level associated with an overbought territory. We also notice that oil prices have broken above the upper Bollinger Band, a chart overlay that shows the upper and lower limit of 'normal' price movements based on the historical standard deviation of prices. This is also considered a momentum contrarian selling opportunity.

However, it should be noted that the width of the Bollinger Bands increases once oil prices start trading above $108 per barrel. Thus, if oil prices trade above this level on the back of further negative news flow out of Iraq, we can expect to see a volatile breakout to around $116 per barrel. This would be a high probability event as prior to the militant insurgency, the 20-day volatility contract in the Brent benchmark was at an all time low of 7.2 percent on June 3 according to Bloomberg data.

Historically, there has not been a strong correlation between rising oil prices and Indian equity performance. In fact, out of all oil shocks of the past 25 years, it was only the 1990 oil shock (Iraq war) that left Indian equities in the red for the next 6 months according to Morgan Stanley research. It may be the case that the 1990 shock pushed India into a balance of payments crisis making it an isolated incident. If we exclude the 1990 oil event, the Sensex has risen 24 percent on average in the six months after an oil shock. During the Libyan crisis in 2011, when Brent

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