The argument can be made that a large portion of the current bull run in nearly all commodities can be explained by a combination of institutional asset allocation in commodities as an alternative asset class (some of it via swaps which allow for unlimited position size regardless of physical availability of commodities due to a loophole in commodity trading regulations) and trend followers, with the sick result of rising prices increasing price further in a positive feedback loop.

I'm generally libertarian and anti-regulation, but the use of swaps to get around position limits on a market that arguably isn't equipped to handle assets of this magnitude doesn't sit well with me. I'm all for speculators in commodities markets creating liquidity and assuming risk, but that's not what this institutional asset class is doing in these markets.

Here is a link to some recent testimony (PDF) before the Senate on the subject:

"In the popular press the explanation given most often for rising oil prices is the increased demand for oil from China. According to the DOE, annual Chinese demand for petroleum has increased over the last five years from 1.88 billion barrels to 2.8 billion barrels, an increase of 920 million barrels.8 Over the same five-year period, Index Speculators' demand for petroleum futures has increased by 848 million barrels.9 The increase in demand from Index Speculators is almost equal to the increase in demand from China!"

and some other articles on the subject,

Guardian (UK)
LA Times
Business Week

Stefan Jovanovich notes:

There have been only three periods of six months or longer since 1972 when Americans drove fewer vehicle miles than they did a year earlier: (1) the 3rd and 4th quarters of 1974, (2) the 4th quarter of 1979 and all four quarters of 1980, and (3) the 4th quarter of 2007 and the 1st quarter of this year. Six months into both of the prior periods was a close to ideal time to buy US equities, but that may be the result of coincidence rather than correlation. Most things are.





Speak your mind

12 Comments so far

  1. Gary Rogan on May 27, 2008 6:27 pm

    Oil production in China rose more than the demand. The world is awash is oil and demand is falling. There is anecdotal evidence of coal replacing oil all over the globe for energy generation. In addition to the fully-exposed consumers cutting back, governments that are subsidizing gas prices feel compelled to reduce subsidies, and airlines are reducing capacity. Oil is being stored in tankers specially rented because land-based storage is filled with capacity. The small increases from Saudi Arabia and Iraq in recent days, as well as the halt to filling the Strategic Oil Reserve will add up. The bubble just started popping and Boone Pickens and Goldman Sachs notwithstanding, the trajectory will look similar to the housing prices collapse. It’s never different this time.

  2. Anatoly Veltman on May 27, 2008 10:23 pm

    Gary: if only you had posted 24 hours earlier, when oil was $133.50 bid (not to mention $135 on 5/22), your indicators would appear priceless.

  3. Gary Rogan on May 28, 2008 1:53 pm

    Anatoly, well at the moment they appear negatively priceless. They also looked a lot better just a couple of hours ago as I write. I had all the information before Friday, and in fact was going to post the comment on Friday because I was quite intrigued by the divergence of the oil-related stock prices and the price of oil itself, but something else distracted me. This would surely make me look like a genius for a day or two. I also only became aware of the Palindrome's recent prediction after I posted, however his was conditional on the recession arriving and I don't believe in that condition, but otherwise the comment was a bit redundant. This was meant as a slightly longer term comment and oil prices will not fall that much differently than the Internet stocks in 2000, with some very confusing fluctuations. Also of course, if somebody starts blowing up tankers in the straights of Hormuz I will definitely look like a fool, but that's what you sign up for with comments like these. I don't know if you remember my prediction from a year and a half ago about the improvements in Iraq a year from that time which indeed came to pass. The political effect of those is much more ambiguous than my prediction was.

  4. Anatoly Veltman on May 28, 2008 5:34 pm

    1. any link re: Palindrome’s?
    2. I was soliciting recommendations the entire weekend; didn’t get any, and ended up disclosing my bias before market re-open. Always fascinating: how observers get to posting contrary-to-price-action opinion only after it appears no-longer-contrary. Also, how sharp unfavorable price behavior rapidly lengthens the “holding term” implied.
    3. Recession isn’t a sexy caveat - granted. Are unpredictable geo-political events mention-worthy?

  5. Gary Rogan on May 28, 2008 5:35 pm

    Well, Richard Berner of Morgan Stanley has decided that this was the best day possible to once again predict $150 oil after it fell by $3. Everybody is in pain, but those hardy developing countries they are just unstoppable and they will not, I say will not, be denied the oil they need, and this important opinion cannot be hidden from the naive markets by the altruistic truth seekers. Mr Berner, you can say anything you want, but oil will see $100 before it sees $150.

  6. manuel bravochico on May 29, 2008 1:24 am

    The market is always right as that's were your p&l is cashed out at. As usual, the best traders don't want to be right, they want to make money. I understand the fundamental points made but also realize you could have made the same points when oil was at $100. This is just another of the dozens of analysis' I've seen over the last few months on why oil is over priced. Yes, at some point it will pull back as will my broken clock display the correct time. The bottom line….oil is up huge…if you trade it… are you up or not. The rest is just mental exercise.

  7. Ronald Weber on May 29, 2008 2:39 am

    Thanks, Dylan for this testimony report, finally we get an intelligent comment on commodities. I've been tired of hearing this China/India and supply nonsense for the past years! I think this report says it all and at some point (next week or next year?) it will be a hard wake up call for many investors. Maybe if it is really a bubble and pops bigtime it could lead to a rally in equity.

  8. gabe on May 29, 2008 1:06 pm

    hold the bubbly just yet…

    “Fresh data from the U.S. Department of Energy show the amount of petroleum products shipped by the world’s top oil exporters fell 2.5% last year, despite a 57% increase in prices, a trend that appears to be holding true this year as well.”

  9. Gary Rogan on May 29, 2008 7:29 pm

    Anatoly, I tried to submit the link but it got filtered, just google his name and “oil prices”.

    The geo-political events are next to impossible to factor other than qualitatively because very small random fluctuations in processes that are not easily observable can lead to dramatic outcomes in this case and there is already a premium built into the price.

    As I said, I had believed in what I wrote since about Friday, but obviously it’s impossible to prove, not that I care. And the prediction is not a day-to-day type.

  10. Gregory Rehmke on May 31, 2008 7:06 pm

    A couple comments on this analysis:

    “Fresh data from the U.S. Department of Energy show the amount of petroleum products shipped by the world’s top oil exporters fell 2.5% last year, despite a 57% increase in prices, a trend that appears to be holding true this year as well.”

    1. First off, this might have been true historically as well. Fields decline and top producers can become lessor producers. After oil shock in 70s, non-OPEC countries expanded market share dramatically over some years. So share of top 15 exporters may have similarly declined then.

    2. Oil exports contribute to corruption. Nigeria, Mexico, Russia, Venezuela government tax and steel significant amounts of export revenue and tend to discourage investment is ways that similarly corrupt countries whose governments are not yet addicted to oil (i.e. Brazil) do not.

    3. WSJ article cites booming oil demand in Middle East and decreasing Saudi exports due to domestic processing of chemicals. But of course that is misleading because had this oil been exported and processed in other countries it would look like more oil exports, but not increase available oil.

    4. Ultimately, the questions are: how long have oil prices been “high”? How long have major producers been confident they would likely stay high or go higher? And how long does it take to bring major new production onstream? When does Brazil’s oil hit the market? And will other fields large and small come to market at the same time?

  11. steve leslie on June 2, 2008 8:48 am

    I am watching Squawk box and Charles Maxwell of Weeden is the senior energy analyst and he states that within 4 years the barrel of oil will go to 3-400 dollars a barrel and gasoline to $15 a gallon U.S. I am not sure how he arrives at those numbers but I am sure for those interested his report is available somewhere. I dont know what it is worth beyond that.

  12. Gary Rogan on June 3, 2008 2:47 pm

    And I’m watching the oil fall, and it will keep falling until it hits $100, like I said. I make very few mistakes when I make predictions.


Resources & Links