Thursday, June 05, 2008

One commodity analyst warns on oil: 'Look out below'


LA Times/Business
http://www.typepad.com/t/trackback/816965/29718292

9:49 PM, June 2, 2008

The stock market had a bad day Monday, but oil escaped most of the blame this time. Instead, the market was primarily rattled by renewed worries about the financial system’s health (or lack thereof), as noted here. The Dow industrial average slid 134.50 points, or 1.1%, to 12,503.82, but it recovered from a drop of more than 210 points.

Oil, meanwhile, had a relatively placid day. Near-term futures in New York closed up 41 cents at $127.76 a barrel. The record closing high was $133.17 on May 21. Could it be that oil has gone as far as it can go for the time being?

One notable bear (a short-term bear, at least) is veteran commodity-market analyst Dennis Gartman, who writes the daily Gartman Letter from Suffolk, Va. He has been warning clients in recent days that crude prices could fall sharply. Amid increasingly intense political pressure, Gartman expects the Commodity Futures Trading Commission to soon crack down on trading in commodity futures by institutional investors who've been riding the bull market in raw materials.

If that happens, Gartman wrote on Friday, "We may be stunned by how far down some commodity prices shall fall." And that threat "is even more seriously to be taken regarding energy specifically," he wrote.

Just one man’s opinion, but Gartman has been analyzing commodity markets for about 34 years.












Comments:

No one can predict the market with any certainty. True, supply has been lower than demand and this is driving up prices--as must be the case...but is demand coming from oil consumers or investors (housing bubble anyone)? Some fail to realize is that high prices can drive up demand rather than suppress it. Just look look at rice...people are stockpiling even though prices are at historic highs. More on point, high fuel prices cause transportation companies to hedge against further increases by purchasing oil backed financial products. These have to be backed by oil assets (i.e. more demand) or someone willing to short sell (which there are too few in bull markets). At some point people will see the risk/reward of oil as too high and stop investing. NO one can predict when and how much, but like housing, demand from investors will cool and when in does we are likely to see price march quickly in the other directions. Check out these two charts: http://randolfe.typepad.com/randolfe/images/housing_projection.jpg and http://cafim.sssup.it/~giulio/other/oil_price/price_real.png

Posted by: D | June 03, 2008 at 08:28 AM

In response to remarks made by 'D', I'd like to clarify a few points. 'Investors' and speculators are two distinctly different things. Also, high futures prices do not 'drive' demand for the asset...they may cause yet higher futures prices but futures prices do not always coincide with cash, or spot, prices, even at a current contract maturity. The difference between the two prices, the basis, has of late been at wide variances, particularly in grains. Transportation companies do not hedge fuel costs by buying oil backed financial products...they buy oil futures contracts..which go out almost 11 years in the future. Further, 'short sellers' are not necessary for transportation companies' BUY hedges as oil producers, who are capable of delivering on their SELL hedges, can utilize their reserves for this purpose. World rice prices were driven up by the relative small supply, vis-a-vis total world production, available for export/import markets. The purchase limits placed by Wal-Mart and others was nothing but a marketing ploy...the U.S. has plenty of rice, notwithstanding the most desired Thai variety. Rice prices went from 15 cents# in January to 25 cents in April back down to 18 cents at present...but rice, unlike oil, is sustainable. You do have markets running out of steam right. Markets become overbought or oversold and then correct....the problem for traders, speculators and hedgers alike, is when and how much. A single oil contract is 1000 barrels (42,000 gals) worth about $125,000 and can be bought or sold for between $5,000-$6,000...a 1 cent price differential = $10.00 and, as everyone knows, prices can move 300 or 400 cents daily. Buy, or sell, 10 or 20 contracts and you will quickly learn the difference between an investment and a speculation.

Posted by: martin a. scanlan | June 04, 2008 at 03:27 AM


Thanks Martin. You sound like one of the more learned peopled I've interacted with on the subject. Although you gave 'examples' illustrating the difference between investors and speculators, perhaps you could define the two for me. Personally, I see no reason to differentiate. Please also forgive me for misusing wall street jargon. My point was that there are financial tools available to those wanting to hedge against further increases, and as prices of those tools (futures, etf's which hold futures, etc) rise, it can create more demand as more entities feel the need to hedge. Additionally, since you seem to understand this process, who generally issues oil futures contracts? I guess my point was, whether or not supplies can keep up with consumption (not demand) is not the only determining factor for price. In our financial markets people can invest (speculate, bet, whatever) very easily. When too many people are betting the price is to go up, the price of placing an 'up' bet rises as there are too few people to take the opposite bet or promise their reserves at the lower price. At some point the underlying asset (or referenced asset, whatever) will also rise. I personally do not trade futures, but I would not be shocked to see a significant pull back on oil.

Posted by: D | June 04, 2008 at 11:24 AM


D:

'investing": the giving of money with the expectation of a profitable return, usually expressed as a percentage of the principal, based on certain facts.

'speculating': all of the above but substitute 'conjecture' for facts.

I used to travel bluenose Oklahoma years ago and could not understand why it was illegal to gamble and have open, public bars and taverns, while it was perfectly legal to speculate on, say, shorting 5M bushels of wheat and do it on the phone while sitting in a private club having a bourbon. My point is that words mean different things to different people. For what its worth, I'd explain the difference between gambling, speculating and investing to my kids thusly: Gambling is when you create a risk where none existed. If you and I cut the deck for $1.00 for a pop, we CREATED a $1.00 risk (on high card). Speculating is when we assume a risk that that does, in fact, exist but can be EXTRA ORDINARY. a farmer might buy a $100K tractor with $10,000 cash down and a $90,000 note expecting its improved performance over his old tractor to produce greater yields and profits...but if a drought or a flood, risks that DO exist, wipe him out he is not only out his normal crop he would have had with his old tractor but is on the hook for the $90K note on the new tractor..he speculated..and lost. An INVESTMENT is putting money into something that empirical evidence tells us we can expect a pre-determined return on the dough we 'invest.' A stock that hasn't missed a 2% dividend yield for 80 quarters, an annuity from a well funded insurance company that pays 4% like clockwork and the ultimate safe investment, a U.S. Treasury Bill, Note or Bond...are INVESTMENTS.

Posted by: m scanlan | June 04, 2008 at 04:21 PM


D:

This might be of some help in understanding futures mkts..though PhDs, computer programs, global commodity operations and transactions, multi-currencies, etc, make for complex equations and strategies...basic principles remain constant. Prices go up, down or sideways and you can go long, short or stand aside.

Imagine it is 1840. You are a flour miller and bakery in Philadelphia. Your projected business for 1841 requires 10,000 bushels of wheat to make flour which in turn will make bakery goods, bread. The wheat growers are in Kansas so you, or your rep, hop a train to Chicago and transfer to a train to Wichita. You meet a wheat farmer in Kansas and agree to buy his next year's crop of 10,000 bushels of wheat at $1.00/bu for delivery in December, 1841 at an agreed to repository. You give the farmer a cash deposit of, say, $500. He gives you a written confirmation of your deal. You now have a "to arrive" contract for 10,000 bu's of wheat @ $1.00 for Dec delivery and settlement of the dough. You head back to Philadelphia. On your Chicago layover you learn you will only need 5,000 bu's of wheat for next year so you head to a bar to ponder what the hell to do with 5,000 bu's you don't need. At the bar you meet a fellow, talk jobs, sports, women and farming, normal bar talk. You mention your wheat "contract" and the 'fellow' just happens to have an uncle in Minnesota that grows wheat and has told him the price of seed by next year will soar and so will the price of wheat. The 'fellow', believing he can sell the wheat in Minnesota for a higher price, offers to buy 5,000 bu's of the Philadelphian's 10,000 bu's for $1.10 and the deal is struck on the same terms of delivery and cash settlement. The farmer has made a short hedge (he hasn't even planted the wheat yet) and knows what his financial situation will be next year, barring catastrophe, by reducing his downside price risk , the baker has made a long hedge for his raw commodity needs and knows his material cost for next year and has doubled his 'good faith' money on 5,000 bu's and the 'fellow' becomes a speculator. The 'open interest' in Dec41 wheat contracts of 5,000 bushels each is 4. The farmer is short 2, the baker is long 1 and the speculator is long 1, (commitment of traders is 2:1 longs)) the last mkt price is $1.10. If the price of wheat does soar next year to say, $1.30, the farmer hedged too early, the baker looks like a mkt wizard and can sell his bread at a more competitive price than his competition that didn't hedge, and the speculator made a killing. Reverse everything and you have a bear mkt. When this type of activity multiplies and grows, it is the beginning of an organized futures exchange on a trading floor. Fortunately, their is a bar on the ground floor.

Posted by: martscan | June 05, 2008 at 06:15 AM

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