Thursday, March 31, 2011

Oil's Endless Bid

I often hear the glut of housing inventory as an explanation for why house prices will continue to drop in the coming years. This Business Insider article explains that the excess inventory is keeping the pressure on house prices.

That makes sense. Too much supply puts pressure on house prices.

The question I have is why doesn't the same thinking apply to oil?

Bespoke Investment Group posted a good chart in this article last week. Check it out.

So, as the chart in the Bespoke article shows, oil inventories are sitting well above the average inventory level since 1984 yet we've got oil over $ 100 per barrel.

I've read and listened to explanations and justifications for why oil prices (and other commodities) are going up by so much (explanations not unlike those justifying high house prices that I remember hearing back in 2005). Some of these explanations may even be partially or completely correct. Obviously, monetary policy has been a big driver of the increases in commodity prices.

It's also possible that the reason has to do, in part, with what Dan Dicker (a veteran oil trader and author of the new book, Oil's Endless Bid) says in this article:

...the "financialization" of all commodity markets, but most particularly oil, has not only unnecessarily pumped up the prices that you and I pay for gasoline and corn and wheat, but has made those prices far more viciously volatile.

In a separate article, Dicker had the following to say about the cause of high oil prices:

It turns out, Dicker says, that the price has nothing to do with supply and demand for oil. It's the financial market for oil, filled with both professional speculators and amateur investors betting on poorly understood oil exchange-traded funds, who have ratcheted up the price of gas to such sky high levels.

Here is another Dan Dicker interview on what he sees as the cause of high oil prices.

It's only one individual's take but, if this is even partially true for oil, I can't see why it may not also be a factor for other commodities.

I think it's difficult to get at the root cause of something this complex but the fact is a large amount of "financialization" of commodities has occurred this past decade. When it comes to problem solving asking what has changed is usually a good place to start.

If distortions are occurring as a direct result it seems foolish for us to not address them. I know eventually prices will be sorted out by supply and demand, but eventually can be a long time. We saw what happened with housing when we juiced prices via the securitization of mortgages for years. That might have been fun on the way up but we're still feeling the economic ramifications of those inflated housing prices now. I still vividly remember experts and other serious folks making very thoughtful and sincere rationalizations of why housing prices were justified back then.

Who says what's happening now with commodities isn't a variation on a similar thing?

I'm not saying the outcome is going to be the same. I'm saying it's better to not wait to find out.

Adam

Related posts:
Ray Dalio on Stocks & Commodities
Financialization of Copper

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