?Record-breaking commodity prices are like the siren’s song luring sailors to crash upon the rocks. Consumers and investors navigating the U.S. and world economies are sailing in treacherous waters.
I am not persuaded that fundamentals behind oil supply and demand, geopolitics or even a weak dollar are changing so rapidly and meaningfully that they support the price of oil going up by a dollar a day, which is what we saw in late April and early May.
This argues for the importance of the rise in speculative trading and flows of cash into commodity-index funds, the subject at press time of a Congressional hearing chaired by Sen. Joe Lieberman.
The price of oil is “getting to the irrational phase,” says John Hardy, foreign-exchange market strategist for Saxo Bank, who was in Houston recently for a conference on forex trading, a specialty of this London-based, online-only investment and trading bank.
Hardy says the size of the commodities market is “a drop in the bucket” compared with worldwide equities and bonds traded on all the exchanges, but private and institutional investors are allocating more money to commodities, which causes prices to decouple from fundamentals.
“We are edging toward a bubble,” he told me. “This thing could continue to the far extreme of $200 a barrel, but I think that’s less likely—$150 looks a lot closer now. But this could peter out if the bubble bursts later this year. Oil could drop to $100 in a flash.”
Commodity bubbles tend to fall faster than they rise. The progression from $100 to $150 might take four or five months, he says, while the “great unwind” could happen in one or two.
It seems to me these price changes are taking days and weeks, not months.
Billions of dollars willing to chase returns on commodities threaten to create an asset bubble, agrees Lehman Brothers chief energy economist Edward Morse. In a recent report, he estimates that total assets under management in commodity indices more than tripled to $235 billion by mid-April from about $70 billion at the beginning of 2006.
“Of this $165-billion increase, about $90 billion is accounted for by financial inflows to these indices, with the remaining $75 billion increase stemming from price appreciation of the original underlying investment,” Morse says.
This tally does not include over-the-counter capital flows, which can sometimes be larger than flows on exchanges, according to his report. Commodity markets are relatively illiquid compared with equities and bonds, Morse says, but the injection of even $1 million can have a major effect in certain commodities.
What should our response be?
We’ve got to have a better national energy policy than for the president to go to Saudi Arabia, hat in hand, asking for more oil production, only to be told the kingdom already hiked its output by 300,000 barrels per day recently—and oil prices still went from $113 to $126.
We’ve got to have a better energy policy than for the federal government to stop buying barrels to fill the Strategic Petroleum Reserve.
The U.S. will not issue any contracts for the bids it has already received from companies that want to supply oil to the SPR, according to a report from Pritchard Capital Partners. Legislation passed by both houses of Congress forbids the government from adding to the stockpile through the end of the year, or until the price of oil price falls below $75 a barrel.
This bill, “a grand gesture” by pandering politicians, would defer 7.9 million barrels of oil that were scheduled to be delivered to the SPR in May, June and July. The amount is less than half the barrels consumed by the U.S. in a single day, so its effect on gasoline prices is likely to be little to none.
Economists still debate what oil price it will take for consumers to change their driving habits and overall energy usage. Analyst Adam Sieminski of Deutsche Bank postulates in a recent report that it may take as much as $250 per barrel to jolt people.
But meanwhile, anecdotal evidence already says consumers are starting to respond. A couple I know who lives in New Hampshire has changed their camping habits out of distaste for gasoline costs. This summer they plan to drive to their beloved Maine coast only once for a camping trip, whereas every summer for the past eight years, the couple went two or three times more often.
After a friend of mine graduated from the University of Houston this spring, her parents gave her a new Toyota Prius as a gift, thinking that will be more practical than any other model.
From the cliffs overlooking the beach in Malibu, eco-chic now takes the form of celebrities building customized, uber-luxurious but green homes with recycled wood used for a dining table, recycled plastics for chairs, recycled bricks for flooring, and solar panels on the roof. These multi-millionaires can afford to get off the power grid, but what about the rest of us?