Commodities Volatility Indicate Firming Demand, Rising Prices

In just the past two and a half weeks, the price of crude oil futures has risen from a low of $32.40 to a high of $50.50. That's a gain of 56%, yet crude is still down by two-thirds from its high of $147 last July. It's hard for me to believe that these wild swings are indicative of huge changes in the demand for or the supply of oil. Surely speculative activity and/or forced sales must account for some significant portion of the volatility.

We see the same pattern in a lot of commodities: after reaching significant highs last summer, prices subsequently plunged, but are now on the rebound. I can only assume that massive liquidation of long commodity positions was behind the price plunge, and that now prices are returning to some semblance of normality, having probably fallen to levels low enough to stimulate demand. Today, with demand firming and in the absence of relentless selling pressure, prices are rising.

So this is good news on two fronts: For one, it means that the plunge in demand that reverberated globally was more an "economic air pocket" than any genuine or lasting economic destruction. Consumers cut back on nonessential spending, and speculators were forced to sell positions to raise cash and pay off margin calls. It all happened in a relatively short period. Prices were probably too high before this began, and they fell too low late last year. Two, it means that the underlying forces in the economy are beginning to improve. We've had massive price adjustments that have cleared markets, and now we can get back down to the business of working and making money.

The improvement in all sorts of key areas—lower swap spreads, lower credit spreads, lower yields, lower volatility, lower energy costs, lower commodity prices—all but rules out the catastrophically bad economic scenario that was implicit in the pricing of equities and corporate bonds just a month or two ago. The economy is most likely doing better than the market fears, but we still have to see evidence of that improvement. That might take at least a few months. But in the meantime I'm encouraged, and I'm not buying into the bears' chant that the current rally is a sucker's rally.

I'm also not of the belief that the current rally is investors' way of cheering Obama's stimulus package. I think it's more likely that the market is rallying in spite of Obama's attempted rescue package. We've known for months that he was in favor of a massive expansion of government, and that was one of the reasons the market was so depressed. Now we find out that 40% of the package will be in the form of tax cuts and rebates, and although rebates and cuts in the payroll tax are hardly likely to be a significant source of stimulus, they are better than having government bureaucrats trying to spend that same amount of money. Call it a relief rally, but it is also clear that we have seen significant improvement in the fundamentals that validates the rally.

Comments

[Storm Cat:]

I almost laughed when I read this story ... the price appreciation we are seeing in crude is nothing more than a technical move ... probably to $55-$56 max... the contango in the market is near historical levels (extremely bearish). Crude inventoroes and approx 33 MMbbls above l;ast yrs levels. Moreover, approx 25 supertankers (2 MMbbls capacity) and being used for storage and 7-10 are in contract for same. Year-on-year demand has dropped 1.55 MMb/d or 7.4%. these are not small issues.

Look at the daily continuation chart. The mkt has dropped from the $147 high last July without any retracement until now. This is a DEAD CAT BOUNCE

Jan 07 08:59 AM

[Storm Cat:]

Supertanker = 2 MMbbls capacity EACH

Jan 07 09:09 AM

[Aly-Khan Sa...:]

I think the Equity markets might have found a bottom.

The only reason Oil has bounced is because of the Contango and a misperception that Gaza carries geopolitical risks.

You might care to look at the Baltic Dry Index. It has been a near perfect forward indicator.

Aly-Khan Satchu
rich.co.ke

Jan 07 09:14 AM

[John Lounsbury:]

Beach Pundit - - -

I just don't get your "analysis". Article after article takes trivia and tries to embue it with meaning. I have said previously I don't like to be insulting, but it is hard for me to make any comment on this without sounding insulting. However, I can't let things that I consider to be ill founded, misleading and incorrect to pass without comment.

I may not know which way the markets are going in the coming months, but nothing you say makes me think you have any idea, either.

Jan 08 01:17 PM

[Kaala Ghind:]

I tend to agree with Calafia Beach Pundit's analysis. Once the speculative air has been forced out of the commodities' bubble, prices will respond to forces of supply and demand and that is what seems to be happening right now.

Jan 08 04:24 PM