Summary
The gold report that I had sent earlier called Gold As Money is throwing up some interesting convergence and seems to have a compelling underlying theme on monetary debasement ; thus gold finding value amongst investors as the buying power of fiat paper money erodes = and that leads as always to hyperinflation eventually< as inflation expectations soar making it a self fulfilling prophecy>
What makes hyper inflation even more of an impending problem is the possibility that Crude oil – Petroleum Products prices may now increase supported by a combination of Geopolitical issues + Decline of Dollar or even more importantly the perception that dollar shall decline even more.
Analysis
Peak Oil
As we've noted in previous article’s, Hubbert's "Peak Oil" theory appears to be valid. It is certainly supported by observation in that many cases can be cited where the production from an oil field or an entire oil-producing region has gone into decline exactly as predicted by this theory. However, we do not believe that geological limitations to oil supply constitute a major economic issue. There are vast untapped oil reserves in the world, and if the oil market were able to operate freely then these reserves would probably satisfy demand for generations to come. Furthermore, the free market would develop economically viable alternatives well before we reached the point where oil supply was limited by geology. In a nutshell, a sustained shortage of a commodity as useful as energy would never occur in a free market.
Which brings us to the root of the problem: the oil market is not free. This, and not any geological considerations, will potentially lead to troublesome constraints on oil supply in the future. In other words, if there is going to be an oil supply problem with grave economic consequences then the origin of the problem will be political, not geological.
The free market is very good at anticipating potential supply shortages and addressing the unanticipated shortages that periodically crop up, but governments around the world have their tentacles deeply immersed in the oil business, from oil exploration all the way through to the consumption of oil-based products. In particular, governments: a) heavily regulate oil exploration and production, b) control or influence the prices of oil and oil-based products, c) attempt to influence energy consumption trends, d) reduce, eliminate, or manipulate in some other way the economic incentives to expand supply, and e) use oil as a means of gaining geopolitical advantage. Here are some specific examples:
* The US government has a history of imposing or threatening price controls and "windfall profit" taxes whenever there is a large increase in the oil price, thus discouraging the oil industry from responding in the appropriate way to price signals. The US government also places severe restrictions on where oil drilling can occur and is about to massively distort both the supply and the demand for oil via its "Cap and Trade" program.
* The federal and provincial governments in Canada have a history of changing the rules (royalties and taxes, for instance) on the oil and gas industry, thus creating more uncertainty than there should be.
* China consumes far more oil than it should because its government ramps up the money supply at a rapid rate and simultaneously caps the gasoline price at an artificially low level.
* Russia has used its control over European gas supply as a geopolitical weapon in the past and will probably do the same in the future.
* Some governments, the Venezuelan government being the highest-profile example, have "nationalised" privately-owned oil production facilities and reserves, to the detriment of oil supply.
The bottom line is that sustained shortages of useful commodities only occur when the government inserts itself into the supply/demand equation. The oil market is no exception, so if insufficient oil supply becomes a serious long-term economic problem then the underlying cause will be political, not geological.
Current Market Situation
If this is the case then the short-term downside risk is much greater than the short-term upside potential. In our opinion, the short-term downside risk is defined by the December 08 and February 09 lows (we expect that these lows will be tested after the post-crash rebound runs its course). We have shifted our short-term oil outlook from "neutral" to "bearish" on the basis that the rebound in the oil price from its early-July low to its early-August high is looking more like a counter-trend move than the next up-leg of an intermediate-term advance. If the nearest oil futures contract closes above its June peak at some point over the next few weeks then we are clearly wrong about this and will immediately shift back to the sidelines.
Considering the economic backdrop, even if the oil price were to break above its June peak ($75 in the September contract) we doubt that it would make significant additional headway. However, we have learned not to under-estimate the effects of trend-following speculation on this market. After all, the oil price was able to rise from the $70s in mid-2007 to the $140s in mid-2008 in parallel with deteriorating fundamentals (rising physical supply and declining physical demand). In that instance, speculation regarding US$ inflation was the primary driver of the price trend.
If the oil price does break out to new highs for the year then the catalyst will likely be a break to new lows by the Dollar Index (improbable, but not out of the question) or rising geopolitical tensions in the Middle East (impossible to handicap). Daily Chart NYMEX crude oil future’s – daily close above 80 dollars suggest an uptrend and getting to overbought levels on the short term - Support now at 76.50 and 73.50 levels on a daily chart
As we've noted in previous article’s, Hubbert's "Peak Oil" theory appears to be valid. It is certainly supported by observation in that many cases can be cited where the production from an oil field or an entire oil-producing region has gone into decline exactly as predicted by this theory. However, we do not believe that geological limitations to oil supply constitute a major economic issue. There are vast untapped oil reserves in the world, and if the oil market were able to operate freely then these reserves would probably satisfy demand for generations to come. Furthermore, the free market would develop economically viable alternatives well before we reached the point where oil supply was limited by geology. In a nutshell, a sustained shortage of a commodity as useful as energy would never occur in a free market.
Which brings us to the root of the problem: the oil market is not free. This, and not any geological considerations, will potentially lead to troublesome constraints on oil supply in the future. In other words, if there is going to be an oil supply problem with grave economic consequences then the origin of the problem will be political, not geological.
The free market is very good at anticipating potential supply shortages and addressing the unanticipated shortages that periodically crop up, but governments around the world have their tentacles deeply immersed in the oil business, from oil exploration all the way through to the consumption of oil-based products. In particular, governments: a) heavily regulate oil exploration and production, b) control or influence the prices of oil and oil-based products, c) attempt to influence energy consumption trends, d) reduce, eliminate, or manipulate in some other way the economic incentives to expand supply, and e) use oil as a means of gaining geopolitical advantage. Here are some specific examples:
* The US government has a history of imposing or threatening price controls and "windfall profit" taxes whenever there is a large increase in the oil price, thus discouraging the oil industry from responding in the appropriate way to price signals. The US government also places severe restrictions on where oil drilling can occur and is about to massively distort both the supply and the demand for oil via its "Cap and Trade" program.
* The federal and provincial governments in Canada have a history of changing the rules (royalties and taxes, for instance) on the oil and gas industry, thus creating more uncertainty than there should be.
* China consumes far more oil than it should because its government ramps up the money supply at a rapid rate and simultaneously caps the gasoline price at an artificially low level.
* Russia has used its control over European gas supply as a geopolitical weapon in the past and will probably do the same in the future.
* Some governments, the Venezuelan government being the highest-profile example, have "nationalised" privately-owned oil production facilities and reserves, to the detriment of oil supply.
The bottom line is that sustained shortages of useful commodities only occur when the government inserts itself into the supply/demand equation. The oil market is no exception, so if insufficient oil supply becomes a serious long-term economic problem then the underlying cause will be political, not geological.
Current Market Situation
If this is the case then the short-term downside risk is much greater than the short-term upside potential. In our opinion, the short-term downside risk is defined by the December 08 and February 09 lows (we expect that these lows will be tested after the post-crash rebound runs its course). We have shifted our short-term oil outlook from "neutral" to "bearish" on the basis that the rebound in the oil price from its early-July low to its early-August high is looking more like a counter-trend move than the next up-leg of an intermediate-term advance. If the nearest oil futures contract closes above its June peak at some point over the next few weeks then we are clearly wrong about this and will immediately shift back to the sidelines.
Considering the economic backdrop, even if the oil price were to break above its June peak ($75 in the September contract) we doubt that it would make significant additional headway. However, we have learned not to under-estimate the effects of trend-following speculation on this market. After all, the oil price was able to rise from the $70s in mid-2007 to the $140s in mid-2008 in parallel with deteriorating fundamentals (rising physical supply and declining physical demand). In that instance, speculation regarding US$ inflation was the primary driver of the price trend.
If the oil price does break out to new highs for the year then the catalyst will likely be a break to new lows by the Dollar Index (improbable, but not out of the question) or rising geopolitical tensions in the Middle East (impossible to handicap). Daily Chart NYMEX crude oil future’s – daily close above 80 dollars suggest an uptrend and getting to overbought levels on the short term - Support now at 76.50 and 73.50 levels on a daily chart
During the past few months major finds have been confirmed in Brazil, Iraq, and Colombia (they need plenty of work before they come on stream) and reserves have been increased dramatically in Saudi Arabia, and then there are the oil sands and oil shales to consider, which will become doable if prices inflate much from here, and then there are deposits in Alaska and the Great basin that are tied in knots by environment issues, and then there are recent breakthroughs in recovery techniques that are generally ignored by the bulls.
It also bothers me that there is no correlation between the size of positions taken in commodities by index funds and the finite amount of goods available. Here I think regulators have been more than remiss and the exchanges utter scoundrels (commission flow rules their approach to self regulation) in identifying these people as commercials. The crux of the matter in all the commodity markets is the same. What is the premium to value that is attributable to speculative positions held by these money lords? Ultimately, they will increase nominal prices for a bubbled item to the extent that usage plummets for it because real world processors won’t be able to pass the speculative premium on. Then the bubblers will move on to price crushed items and bubble them:
Its true that demand cover is comfortable, crack margins have imploded, this year global demand growth is expected to be fully met by supply growth from Non-Opec leading to stock piling in the second half of 2008, spot demand has been driven a large extent by demand from Governments looking to fill reserves… All these things in the past would have invited lower oil prices … But its not happening this time…..Oil surge is just like what nickel did, before its reversion during first half of 2007…
- Dollar - Financial markets and money supply - - Backwardation - Little action from the government…
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Money needs a haven to get parked, with hedge fund managers finding the financial market treacherous, found a life line with strong commodity prices… Higher prices attract more people…virtuous cycle, till the marginal cost of liquidity far exceeds the expected marginal return…The same thing is being played here… we need to watch more technical factors to ascertain when that tipping point shall come.. viz: OI, volume, backwardation, oscillators…
Of course, one big question to ponder when it comes to markets is how Oil will fare in an upcoming, perhaps global economic contraction. To this end, with the Oil market showing some signs of near term weakness, we thought we would spend a moment and try to understand where Oil may be headed in the months ahead.
Back in 2008 that prices had come up against important price resistance and we took pains to note the complexity of the situation as we knew that the grudge match of an approaching recession versus a weak currency would be complex and dynamic to assess in real time. Yet, today’s circumstance is radically altered by the recent turn by the Fed toward a policy of monetary easing. In doing so, the Fed is kicking out the support from underneath the US Dollar in a move for which they will almost certainly eventually pay for dearly. Opening the door to a currency crisis is no solution to a bad debt problem, except it spreads the pain over an even wider number of individuals, in this case, everyone holding dollars.”
This author consults with leading institutions through GLG
Analyses are solely the work of the authors and have not been edited or endorsed by GLG.
