Commodity bubble ?
One thing that I hear about over and over from the talking heads on TV and the mainstream media is that commodities are in a bubble about to burst, sort of like the dot com bubble. Could this be true ?
Commodities are supply and demand driven and most commodity demand is driven by its commercial/social application, except for may be Gold. Gold obvisously has some investment demand. Gold is easy to store unlike Crude oil, Natural Gas or Copper. Price of these commodites are driven by Supply and Demand situation.
The price quoted for most of these commodities are scheduled for delivery in 2-3 months time. Most of the speculators in the commodity market has no intention of taking delivery on the futures contracts they trade and they exit well before it is time to take delivery. So if there is a glut of crude oil like some of these so called experts suggest, a bubble will not sustain beyond a 2-3 months period. If there is a glut of contracts in the market that the speculators are trading up, when it is closer to delivery, there will be a massive exodus from these commodities and price will collapse. We have seen this happen with Natural Gas futures last winter. But most other commodities including crude oil, base metals and precious metals have been in a sustained bull market for years and somebody is actually taking delivery on all those contracts. How much "overpriced" copper and crude oil can you store in your basement ?
This is not to say there is no uncertainity or fear premium in the price of crude oil. I believe there is. But the notion of Crude oil prices retreating to $25 a barrel is ridiculous at best. Could prices retreat from the current levels ? yes it could. Will it retreat ? I wish I knew for certain. The only two scenarios that could lead to a substantial drop in commity prices are a 1) a drop in demand or 2) an increase in supply.
As far as the dropping demand goes, it would take a severe recession on a worldwide basis to see a substantial drop in the price of commodities. This is very bullish for commodities long term because the supply situation will remain unresolved.
An increasing supply is nowhere to be seen on the immediate horizon. As for Oil, we might have already entered the terminal decline in the production of the precious resource or we very soon will.
I do not want to pretend that I am an expert commodity trader. I am not, far from it. Just a computer engineer trying to apply some common sense logic. But if you see any discrepancy in logic, please post your comments.
Commodities are supply and demand driven and most commodity demand is driven by its commercial/social application, except for may be Gold. Gold obvisously has some investment demand. Gold is easy to store unlike Crude oil, Natural Gas or Copper. Price of these commodites are driven by Supply and Demand situation.
The price quoted for most of these commodities are scheduled for delivery in 2-3 months time. Most of the speculators in the commodity market has no intention of taking delivery on the futures contracts they trade and they exit well before it is time to take delivery. So if there is a glut of crude oil like some of these so called experts suggest, a bubble will not sustain beyond a 2-3 months period. If there is a glut of contracts in the market that the speculators are trading up, when it is closer to delivery, there will be a massive exodus from these commodities and price will collapse. We have seen this happen with Natural Gas futures last winter. But most other commodities including crude oil, base metals and precious metals have been in a sustained bull market for years and somebody is actually taking delivery on all those contracts. How much "overpriced" copper and crude oil can you store in your basement ?
This is not to say there is no uncertainity or fear premium in the price of crude oil. I believe there is. But the notion of Crude oil prices retreating to $25 a barrel is ridiculous at best. Could prices retreat from the current levels ? yes it could. Will it retreat ? I wish I knew for certain. The only two scenarios that could lead to a substantial drop in commity prices are a 1) a drop in demand or 2) an increase in supply.
As far as the dropping demand goes, it would take a severe recession on a worldwide basis to see a substantial drop in the price of commodities. This is very bullish for commodities long term because the supply situation will remain unresolved.
An increasing supply is nowhere to be seen on the immediate horizon. As for Oil, we might have already entered the terminal decline in the production of the precious resource or we very soon will.
I do not want to pretend that I am an expert commodity trader. I am not, far from it. Just a computer engineer trying to apply some common sense logic. But if you see any discrepancy in logic, please post your comments.
posted by Oil Shock at 4:11 PM
2 Comments:
You have exactly same thoughts I have had since media first time started to talk about commodity bubble. So far I haven't had any answers to my questions. Sometimes I think that people cannot understand that there's big difference between stocks and commodities. Storing cost of stocks is miminal, with commodities it can be huge. And commodities are produced and consumed. Stocks are not.
Well, because I cannot get my answers, I'm even more conviced that there is no bubble in commodities. And so I keep my long position in commodities. When I'll start to see people changing their cars to scooters I'll start to think about sellling my futures. So far there's very few scooters on the streets.
Economists don't understand scientific limits to growth and expansion. Julian Simon was the worst offender in this regard, in my view, but the mantra of 'growth' pervades all economic thinking.
To an economist, energy is fungible, if oil gets too high, the market produces alternatives. They willfully misunderstand the intrinsic energy density and portability of fossil fuels, and dismiss the notion of peak oil out of hand, since it comes from a geological perspective, alien to economic theory.
So you get talking heads like Larry Kudlow seemingly outraged and yelling about "Oil.com", as if energy companies, with their low P/E ratios and A++ income statements are even remotely equivalent to a money-losing Internet pet food store.
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