Posted on 05/25/2008 7:38:17 PM PDT by shrinkermd
After being buffeted by the dot-com, housing and credit bubbles -- not to mention the Chinese stock-market bubble -- there is a readiness by people on Wall Street and elsewhere to ascribe the term "bubble" to all sorts of things. But when it comes to commodities like crude oil and corn, that may be off the mark.
...But figuring out whether a commodity exceeds its fundamental value is difficult: Because there is no income stream, there is no equivalent to the price-to-earnings ratios that people use to value stocks.
Prices, to be sure, are soaring -- crude oil fetched $132.19 a barrel in New York on Friday, up 103% from $64.97 a year earlier. Yet crude has posted similarly massive increases a number of times in the past three decades.
....In the meantime, the response of oil producers to rising oil prices seems more sluggish than ever, leading worries that crude production has peaked.
The Paris-based International Energy Agency, which is conducting a comprehensive study of the world's top oil fields, is preparing to revise its oil-supply forecast downward.
...In February, the board of the California Public Employees' Retirement System, or Calpers, the largest pension fund in the U.S., authorized putting as much as 3% of its $240 billion portfolio in commodities. Hedge-fund manager Michael Masters told a U.S. Senate committee last week that institutional investors "are one of, if not the primary, factors affecting commodities prices today."
But Bianco Research's Mr. Simons say that because the final buyers of commodities are consumers rather than investors, the role of speculation is limited. "Commodities, unlike financial assets, cannot take on hope values very much," he says. "At some point, the price gets to the point where the buyer walks away."
(Excerpt) Read more at online.wsj.com ...
Bubble? In commodities, their tops don’t look like rounded bubbles, more resemble like spikes.
Thus for there to be a build-up of oil, someone would have to be accumulating massive stockpiles of the stuff.
To all those who are pushing the bubble theory, I have just one question: where are the stockpiles? Because, frankly, I don't see 'em.
What am I missing?
The bulls on oil are relying on comments similar to what Boone Pickens made last week on CNBC. He said that the world is producing 85 million barrels of oil a day, and the demand is for 87 million barrels of oil a day. So the price has to continue to go up. The possible error in this is that the demand, at least in the US, which is the biggest factor, could slip. There are signs that Americans are already cutting back. Also, third world countries who have been subsidizing oil (and thus creating lines at the pump) will reduce this subsidizing as it is bound to be costing the government a lot. Further, a slow down in third world ecomomies is not out of the question. At the same time, these high prices ought to boost supply at least a little, though it appears true that the large reserves for example in Saudi Arabia have peaked out. So there is a good chance that the supply demand balance will tilt to push oil prices down. But from just what level, who knows.
And corn? What about that?
Thus for there to be a build-up of oil, someone would have to be accumulating massive stockpiles of the stuff.
To all those who are pushing the bubble theory, I have just one question: where are the stockpiles? Because, frankly, I don't see 'em.
What am I missing?
Here's one persons take on the numbers -
In the US, stockpiles of oil climbed by almost 12 million barrels in April according to the May 7 EIA monthly report on inventory, up by nearly 33 million barrels since January. At the same time, MasterCard's May 7 US gasoline report showed that gas demand has fallen by 5.8%. And refiners are reducing their refining rates dramatically to adjust to the falling gasoline demand. They are now running at 85% of capacity, down from 89% a year ago, in a season when production is normally 95%. The refiners today are clearly trying to draw down gasoline inventories to bid gasoline prices up.
http://www.globalresearch.ca/index.php?context=va&aid=9042
My opinion - It's a classic bubble. Lower demand, higher inventories, nothing near a shortage. Yet the prices have gone up 30%+ in no time at all.
What you are missing is the impact of something called economic rents (see Adam Smith). When a commodity (land in Manhattan, oil, etc.) has a relatively fixed supply, independent of price, and when the "value" to a consumer is far above the cost of production, a bargaining takes place in the market to set the price at which the commodity will trade, and an arbitrage opportunity exists for the speculator when the current market price is below the value for the customer.
For oil the value to the consumer of a week's worth of gas is very high. It is some reasonable fraction of the weekly salary of a job you would not otherwise be able to get to, etc.
It's nothing new. Real estate brokers and flippers have been doing this for a long time in select markets.
BS. Anyone who has spent any time looking at futures markets realizes that they are the most speculative and volatile things around, filled with hopes, fears, predatory trading, guesses as to the future, the length of the huricane season, etc. etc.
Gasoline consumers are free to walk away. Unfortunately they cannot drive away unless they buy gasoline.
You just gave the textbook explanation of how the fair price of a commodity could be above the production cost. It was very well put, BTW.
My point, which doesn't disagree with yours, is that if there is a speculative bubble in oil prices, then we should be seeing a buildup in oil inventories. I see no evidence for that.
Henec I'm inclined to believe the current prices are justified by fundamentals.
You can look at the data for yourself:
http://tonto.eia.doe.gov/dnav/pet/hist/wcestus1w.htm
Last available datapoint: May 16, with stocks (excluding the strategic reserve) at 320 million barrels.
Same time last year: 344 million barrels.
May 2006: Also around 344 million barrels.
In 2005 they were around 330 million.
If anything, the stockpiles are going down.
My source used the EIA numbers. Did it report them incorrectly?
That source charts absolute inventories. It’s doesn’t chart them vs. demand. The absolute doesn’t matter much. What matters is their level vs. demand...
I agree that a genuine bubble would result in accumulation of unsold inventory. On the other hand, if supply and demand were exactly matched with fixed production price, but an arbitrary "value" to the purchaser then there is a broad range of possible negotiated sale prices, and a speculator can arbitrage the difference in current market price and maximum sale price without accumulating any inventory.
I would agree that that would not constitute a classic bubble, where prices would return to some prebubble price after the accumulated inventories were resold.
I have seen this before in a certain real estate market where a new broker in town (Caldwell Banker, actually) realized that incomes would support much higher real estate prices than the current market transactions, and worked on sellers, and with some of their own money purchasing "underpriced" inventory for resale, brought prices up a lot. This was before the "Greenspan property bubble."
It is my understanding, based on what I've heard on Financial Reports on the radio, that OPEC has expanded its membership, adding Angola and Ecuador, but rolled their production into its quotas, thereby REDUCING the amount of barrels on the market. This is why, first VP Cheney, and President Bush, have tried to jaw-bone the Saudis to increase their prodction.
I believe this is a strategy by the Gulf Nations to increase the price of oil, thereby increasing the funds flowing into their Sovereign Funds, and buying up assests in the West.
I believe this is a type of Econmic Warfare, especially as they are increasing the interests in Media and Educational institutions to influence and control information about them.
If you look at the May 2008 numbers, however, they are about approximately the same as during the last 3 years; they're actually lower.
As far as inventory relative to demand, I see no evidence of a change. The article reports a very small decrease in projected US demand, of about 0.2 million bls/day. That's about 1$, which also happens to coincide with the decrease in inventories.
I'm sorry, but the evidence of a bubble just isn't there.
Actually, that's not true. In the presense of fixed supply, the market clearing price will equal the value to the marginal consumer.
There is only room for arbitrage by speculators if the producer charges less than that value.
Now, of course, the question is, why would producers charge less than that value? Are they stupid?
No. They just don't like risk. With demand shifting all the time, it's very hard to forecast what the marginal consumer's value is going to be ahead of time. So producers will sell a significant amount of oil on the futures markets to speculators at a fixed price. The speculators then absorb the risk that the price might fall. However, on average they will end up ahead; the producers are willing to give them this upside in exchage for offloading some risk.
So no, they didn't adjust for the season. But they did compare reserves to demand. If the reserves are at historical averages but demand is down shouldn't we be seeing the prices decrease?
Yet instead we've seen quite an increase in prices. Similar to the increases we've seen in many other commodities. I see that as a clue in and of itself...
Not necessarily. First of all, they just showed some evidence that US demand is down. But oil is sold in a global market. US demand could very well be down, but it's global demand that matters.
Second of all, Mastercard strikes me as a pretty sketchy source for even US oil demand. There are many gasoline purchases that don't get processed via Mastercard.
And finally, I don't see a drop in US demand in the EIA data. It's not as up to date (it ends in February), but oil prices were already high 3 months ago. If there is a bubble now, there was likely a bubble back then, too.
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