Thursday, March 5, 2009

Oil may touch $75 as China hedges US Treasury risk

After falling from $147 to $35 per barrel towards the end of last year, crude oil has once again gained and touched $45 per barrel on increased speculation that China’s stimulus plan may spur demand for the commodity near term. However, some experts are of the view that this is not just speculation but real purchases driving the prices up.

China is said to be considering buying crude oil as part of its strategy to diversify holdings from US Treasuries. This is to hedge against the risk of US Treasury prices dropping and dollar depreciation in the long run, with the Obama government issuing government bonds worth dollar trillions to finance economic stimulus measures.

China has about $2 trillion in foreign reserves, the largest in the world. It put Japan behind as the No 1 holder of US Treasuries last September. Two-thirds of China's foreign reserve assets are said to be dollar denominated, according to the business daily.

With the US economy in the doldrums, these government bonds aren't as attractive as they used to be. China has already said they want to diversify away from them, though nobody thinks there will be a wholesale dumping of US bonds.

One of the Chinese top brass recently hinted that the country may review its large purchases of US Treasuries, saying that future buying will be adjusted to meet the nation's need to maintain the value of its foreign currency reserves.

Even Warren Buffet has warned of low US government debt yields in his recent letter to the shareholders. He says: “The U.S. Treasury bond bubble of late 2008 may be regarded as almost equally extraordinary to previous bubbles in housing and internet stocks.” He says the government stimulus efforts will likely generate an "onslaught" of inflation.

Although the scale of the potential oil purchases by China is unknown, buying 100 million barrels would amount to $4 billion at current market prices--representing only 0.2% of China's foreign reserves.


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