2011 has been so far a volatile year for oil prices. Oil prices started the year at the $80 levels, when it shot up to the triple digits level post the Libyan crisis, as 1.5 million barrels a day were cut from the oil market. The past couple of months has seen oil prices on the downward trend. In May, fears of a lack of global recovery (lower US growth, Euro debt crisis) caused questions about demand for oil, leading the price of the commodity to depreciate. Then came June, where supply was the issue rather than demand.

In the oil market in June, we saw two camps rising: A camp that wanted to see oil prices decline, and another camp that wanted oil prices to remain at the triple-digits level. It is not a fight between producers of oil and consumers, as the world’s biggest exporter (Saudi Arabia) was in the former camp, wanting oil prices to decline to reasonable levels. During an early June meeting of OPEC, Saudi Arabia pushed for an innotiative that would see OPEC’s prodcution increase by more than 1 mn barrels per day. Saudi Arabia was supported by Kuwait, UAE, and Qatar, while Iran, Algeria, Venezuela, and Angola opposed the measure. After failing to increase the production targets, Saudi’s Oil Minister called the meeting one of the most disasterous OPEC meetings. The Saudi’s, claiming that high oil prices diminish demand and global growth, went ahead and increased produciton. Kuwait’s oil minister also announced that Kuwait will meet the Global demand for oil. The riveraly between Saudi Arabia and Iran can also be seen politically, where the two nations are trying to control the region, especially turing these turbulent times.

Last week, The International Energy Agency (IEA) came out and said that the are releasing 2 million barrels of oil per day for 30 days to cover the Libyan shortfall, as these high oil prices are hurting global growth. This sent oil prices down by 5%. The IEA’s move is significant as the Agency has acted twice prior to its recent move, once in 1991 during the Iraqi occupation of Kuwait, and again in 2005, during Huracaine Katrine, when the US was in-need of refined products. Though the move is temporary, as the Libyan oil is thought to stay out of services until the end of the year. The IEA’s move can also be seen as a market stimulus, especially during the end of QE2, as the increased supply of oil will lead to lower oil prices, and higher economic growth.

Oil prices went down 12% in June, and are down 20% from their peaks.

Gold increased to a record high in its fourth day reaching USD 1,474.60 per once. This rally was mainly attributed to the renewed Euro zone fears and inflation, which was backed by the increase in corn and oil prices.

Adding on the above, the weakening of the dollar which decreased by 1% relative to the euro fueled the rally. Analysts are expecting further dollar declines as a result of the widening interest rate differentials after the ECB increases interest rates for the first time since 2008.

Gold also broke a very important technical resistance of USD1,466 an once on Thursday. If this rally continues this week, Gold will target USD1,500 an once.

Gold remained below its all time inflation adjusted highs, which is estimated to be at almost USD2,500 per once in the 1980’s post cold war tensions, oil shocks and hyperinflation.

Oil prices have surged over 25% since the onset of the Libyan crisis on February 15th. The geopolitical risks in Middle East region warranted a risk premium to oil prices as protests from Bahrain to Libya increased oil supply uncertainty. Libyan rebels have been marching towards Tripoli with support of the Allied forces. They recently captured the oil port of Ras Lanuf and a resolution of the crisis seems closer.

Also, the risk of unrest spreading to Saudi has been diminished as King Abdullah proposed several economic reforms and Bahrain has stabilized. Couple these factors with a huge surplus of oil in the U.S. and a well-supplied oil market and the logicial conclusion would be an immenint sell-off in oil prices. Thus, I think oil prices will go down to around $90. What do you guys think?

Oil is breaking new highs on a daily basis. This is worrisome indeed as it exacerbates the evolving inflation story. That mere inflation story may transform into a scary stagflation theme if oil stays high or surges higher, thus, prematurely ending our infant economic growth story.

It is a time of celebration in Kuwait. This may be part of my optimistic view. Yet, a bigger part is actually based on fundamentals. I do not believe oil will maintain the current $114 level or rise further. To support my view, please refer to the charts below which put the contagion risk in perspective. Comforting enough, Saudi’s spare capacity can easily cover production disruptions in Libya and Egypt! Saudi, with minor help from Kuwait and the U.A.E., can also make up for Algeria’s production if it faces issues in the future.

When one combines the above data points with lower demand from slowing emerging markets and ample oil reserves in the U.S., we can deduce that the current rise in oil prices is a temporary fear-driven dislocation in the market. That is why I would recommend shorting oil at these levels.

Tunisia came as a surprise not only to the Arab world, but to everyone; it changed the rule of game. As I watched Mubarak’s speech on Tuesday I thought that not calling for early elections and an easy transition of power as his pledge to step down was dismissed as too slow. Clearly there is no return to status quo in Egypt, but is it a positive change? Certainly could be, but that remains to be seen. Yet the important question was will contagion effect be contained or will it spread similar to the Euro periphery sovereign debt story.

Looking at credit markets one can notice that credit markets price in limited contagion risk, at least so far. Credit spreads on sovereign entities in the Middle East started to widen sharply last November due to the political unrest that started in Tunisia. As the situation started to worsen, spreads widened as investors started to assign a higher probability to a severe political scenario in the Middle East and perceived greater market risk in the area. Interestingly, Egypt’s sovereign five-year CDS spread is now 433 bps, which roughly equals that of Portugal. Also, both countries have a B2 CDS-implied rating.

Two important gauges to consider monitoring in assessing the broader impact of events in the Middle East are the price of oil and the CDS spread of Israeli government debt. Thus far, the Suez Canal doesn’t seem to be under serious threat and there seems to be no interruptions to the flow of oil through the Canal. While oil prices have risen, investors still haven’t assigned a higher probability to a scenario of interruptions. As for the CDS spread of the Israeli government, the five- year spread has widened from 116 bps on January 26^th to 145 bps on February 1^st but not as much as the other countries in the region.

All in all, the market seems to price in a scenario of limited contagion risk as indicated by oil prices and CDS spreads.

According to Goldman Sachs Group, about 2.5% of the global oil production is transported through the Suez Canal.

The insurance against the Egyptian debt (CDS) rose by 39.9%.

It feels like the market wants to see oil at $100 per barrel with Brent crude hovering around it already. Yesterday was the first time oil prices rise above $98 since October 2008, as the Brent touched $98.46 briefly in London before falling back to $97.77 while the light sweet crude (WTI) rose to $91.74 in New York.

We were expecting oil prices to test those levels but no so quickly, with  $100 a barrel being only a matter of time. (Buy Oil Now?) The rally has been driven by the cold weather in Northeast US, drop in existing stockpiles, and the recent closure of the Alaska oil pipeline. Not to mention the rising speculation of slowing down production in the Gulf of Mexico by Obama’s administration by increasing the liability cap for damages when companies drill offshore. As for the long-term growth, the Energy Information Agency (EIA) states that global consumption of oil is expected to increase due to the resurgent demand driven by improving economies in both the developed and developing world. Forecasts also claims that oil demand is expected to reach 88.6m barrels a day during 2011 from 87.78m estimated last month. With the OPEC having no intention of increasing production and the fragile global growth, high oil prices can become a threat for the global recovery.

Naturally, the supply constraints and concerns of the leak sent a shiver down the oil markets pushing up prices of oil while holding down BP. BP stock took a beating as it owns a 46% stake in the Trans-Alaska pipeline and I believe the incident signals a buying opportunity for BP. Nonetheless, we aren’t exactly facing a major disaster similar to the Gulf oil spill as Alaska’s key pipeline has resume shipments and was pumping 400,000 barrels per day, almost two-thirds of its normal levels already.

Supply constraints are pushing up crude oil and increased global demand is expected to enable it to sustain elevated price levels; at the end of the day, BP will take part in the rally.

Looking back at 2010, one of the bets I really regret not being part of was the Gold trade. But was it really the best? Not actually. In fact, it was merely the most publicized. Since the beginning of 2010, we had portfolio managers visit our offices to share their outlooks and sell their products. ALL were betting on gold. Some were even so bullish that they had created Gold share classes to their regular funds. Gold was a very crowded trade as people started buying anything with a shine similar to that of the yellow metal. In fact, precious metals were the biggest winners of 2010.

Looking at the three charts below, one has to question the real driver of performance for each asset class. Was it the dollar trade? QE2 trade? Europe contagion? Were fundamentals the real driver or was it only a result of a flight to quality?

Saudi Arabia is increasingly looking towards the East to do Business, rather than the traditional Western partners. Ever since coming to the throne in 2005, Saudi King Abdulla has been strengthening Saudi ties with the East. He made official visits to China, India, and other Asian countries. China, last year, became the biggest importer of Saudi oil, edging out the US. More and more Chinese companies have been coming to Saudi Arabia to build infrastracture projects, as well as petrochemical projects. The trade flow is not only one-sided, as Saudi Aramco has built two refineries in China. China is looking to increase its exports to Saudi, exporting such goods as food, hardware, textiles, and heavy industrial equipment. Saudi like the lack of political condition attached to the economic ties, unlike the US who keeps discussing Saudi’s human rights trackrecord, as well as the lack of democracy.

However, the picture is not all rosy, and Saudi has not fully shifted towards the East. Saudi still relies on the US for its weapon technology, as well as military support. Saudi also relies on the West for educated labor (engineers, doctors, etc.). Some problems exist with China, as China has accused Saudi companies of dumping Petrochemicals into the Chinese markets. Also, China Railway Construction Company, the company that built the Mina-Arafat Railway, is threatening to sue the Saudi government due to the large losses they accumilated from the project.

In the midst of the political abyss, I tried to find a shining point that could lift us up. Next year should be even better for the Kuwait SE as the development plan gets rolling, the Zain saga will be over, oil potentially will spikes to above $100, and the long-awaited Capital Markets Authority rolls-up its sleeves!