[Marxism] More on oil speculation

bauerly at yorku.ca bauerly at yorku.ca
Sun Jun 8 09:37:19 MDT 2008

Speculators inflating commodity bubble?

Nick Massey
The Edmond Sun

EDMOND — Before backing off, crude oil recently hit the $135 per barrel and some
analysts now see $200 oil as a real possibility. I do as well, although not
until late 2009 or so and not until after some type of meaningful correction
near term. Meanwhile, food riots have broken out across the globe as millions
of people effectively have been pulled back below the poverty line due to
soaring costs for basic necessities.

Whenever prices of anything have gone up dramatically, many people are ready to
blame it on “speculators.” While speculators may have some short-term effect on
prices, most investment professionals, including myself, largely discount such
notions. In a free and liquid market, it would be difficult for speculators to
have that much influence. However, recently I came across evidence that
suggests it might actually be true.

Research has shown that commodities go through typical boom and bust cycles
every 29 to 30 years and reaches extremes in the late stages of this cycle. The
last peak was in 1980. But today, something new has entered the picture.
Commodity indexing has created an enormous source of new demand from large
institutional investors that has absorbed much of the market’s liquidity. It is
this new breed of broad commodity index funds that allocate blindly to all
sectors — as well as the popular gold, oil, and other specialized ETFs — that
have increasingly fueled this bubble as much as the industrialization of China
and the developing world.

In testimony before the U.S. Senate recently, hedge fund manager Michael Masters
offers the best commentary on the commodities bubble that I have seen to date.
In essence, Masters pointed out that commodity prices have increased more
during the past five years than at any other time in U.S. history. Commodity
price spikes have occurred in the past as a result of supply crises, such as
during the 1973 Arab Oil Embargo. But unlike previous spikes, supply is ample.
There are no lines at the gas pump and there is plenty of food on the shelves.

We are experiencing a demand shock coming from a new category of participants in
the commodities futures markets: Institutional investors. Specifically, these
are corporate and government pension funds, sovereign wealth funds, university
endowments and other institutional investors. Together, these investors now
account for a larger share of outstanding commodity futures contracts than any
other market participant.

Why is this a big deal? Traditional speculators provide liquidity by both buying
and selling futures. Index speculators buy futures and then roll their positions
forward. In other words, they never sell. Therefore, they consume liquidity
instead of providing it. While the commodities markets always have had
speculators, never before have major investment institutions seriously
considered the commodities futures markets as viable for larger scale
investment programs.

The most popular explanation for rising oil prices is the increased demand from
China. According to the Department of Energy, annual Chinese demand for
petroleum has increased in the past five years from 1.88 billion barrels to 2.8
billion barrels, an increase of 920 million barrels. In the same five-year
period, Index Speculators’ demand for petroleum futures has increased by 848
million barrels. In other words, they have almost created another China in
terms of demand. Do you think that might have an effect on prices?

In fact, Index Speculators have now stockpiled, via the futures market, the
equivalent of 1 billion barrels of petroleum, effectively adding eight times as
much oil to their own stockpile as the United States has added to the Strategic
Petroleum Reserve in the past five years.

According to Masters, the same situation exists with food prices. Food prices
have skyrocketed in the past six months. Economists typically focus on the
diversion of a significant portion of the U.S. corn crop to ethanol production
as part of the rise in prices. What they overlook is the fact that
Institutional Investors have purchased more than 2 billion bushels of corn
futures in the past five years. Right now, Index Speculators have stockpiled
enough corn futures to potentially fuel the entire United States ethanol
industry at full capacity for a year.

Index Speculators’ trading strategies amount to virtual hoarding via the
commodities futures markets. What if someone came up with a way for investors
to buy large amounts of pharmaceutical drugs and medical devices in order to
profit from the resulting increase in prices, making these essential items
unaffordable to sick and dying people? Society would be outraged. Where is the
outrage about the fact that people all across the world must pay drastically
more to feed their families, fuel their cars and heat their homes?

Traditional speculators go buy and sell and sometimes take physical possession
in the end, thus providing liquidity to the real commercial users of the
commodities and providing a useful service. The indexers do just the opposite.
Rather than provide liquidity, they compete for it. And their insensitivity to
price and supply/demand factors compounds the problem.

This clearly has helped fuel the commodity bubble, but it does not mean that we
should expect an imminent crash. A correction of some sort is likely near term,
but when and how much is anyone’s guess. As Lord Keynes famously said, “markets
can stay irrational longer than you can stay solvent.”

This level of speculation, greater than in the 1970s, almost guarantees that
this bubble will become more parabolic in the next year or so and will create
extremes that ultimately will force both a major correction in the U.S. and
global equity markets and a global downturn. When this bull market in
commodities finally cracks, look out below. Thanks for reading.

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