Commodities' Blame Game

Commodity prices have taken it on the chin lately. The CRB Index, for instance, has fallen 12 percent since mid June. The move has been attributed in large part to strength in the U.S. dollar and continued signs of economic weakness among the developing nations. While the U.S., Europe and Japan may indeed remain weak for a time, from where we sit the worst is over for key commodities, namely gold and crude oil.

Wednesday gold closed below $908 an ounce, a pullback of 8 percent from its recent highs. The case for gold remains as strong as ever, for all of the reasons we’ve recounted in past issues. Although we obviously can’t rule out the possibility of the metal pulling back further—to $880 in a worst-case scenario—we fully expect gold to take out its recent high above $985 in the next couple of months.

It’s a similar, although somewhat more nuanced, story with crude oil. Black gold is oversold on a very short-term basis and due for a bounce. It may not return to $70 all that quickly but it offers decent upside potential for speculators. Looking a bit further out, we can still see crude dipping to $50s if the OECD nation’s economies continue to contract. Looking towards 2010, the outlook becomes much more bullish.

Wednesday, the International Monetary Fund (IMF) offered a revised appraisal of the global situation. While the IMF’s economists didn’t have many encouraging words for Europe (a 4.8 percent GDP contraction this year and a 0.3 percent decline in 2010), or for the U.S. for that matter (only 0.8 percent growth in 2010), they offered a much more upbeat assessment for emerging economies.

The developing world, which now accounts for approximately half of the globe’s output, is expected to grow at a 4.7 percent pace next year. Leading the pack was…wait for it…China, which is anticipated to grow by 8.5 percent. Another notable nation included was India with a forecast of 6.5 percent growth. If they achieve growth anywhere near those targets, the emerging economies will require a good deal more energy.

Here in the U.S., meanwhile, it appears that energy usage is no longer falling, having leveled off at around 18 million barrels per day. Remember that this is in the context of an economy that arguable is still falling. Now suppose the economy bottoms out by year’s end. And for the sake of argument, suppose that we merely generate 1 percent annual GDP growth. That’s on the low side of what typically occurs on the right side of a recession, but we’re not holding our breath for 4 or 5 percent GDP gains. Still, it’s a safe bet that domestic energy consumption will once again be on the upswing. That will add further to the upward pressure on oil prices.

The Blame Game

The Commodity Futures Trading Commission (CFTC) announced the other day that it will hold hearings this summer to consider imposing position limits for energy commodities, including oil and natural gas. Driving this move is outside pressure from the misplaced belief that reducing the role of speculators will prevent participants from becoming overly exposed to the market, dampen price volatility and (left unspoken), prevent oil prices from again climbing to $147 a barrel where they were about this time a year ago.

While the sentiment behind this paternalistic action may be the best intentioned, it will have little real impact on prices. Speculators are found in any market, but their presence doesn’t automatically mean they’re causing prices to rise or fall to a meaningful degree. What’s needed is greater transparency, not position limits. Greater disclosure would add to the available information, allowing participants to make more informed trading decisions.

Sharing this view is the International Energy Agency (IEA). Nobuo Tanaka, the IEA’s Executive Director believes greater transparency on who is trading commodities futures markets is essential to reduce oil price volatility. Tanaka added that speculation can amplify price movements, but doesn’t trump fundamentals in determining the price of oil.

It’s a bit surprising the proposal has gained any traction, considering that the CFTC’s own investigation of the matter previously concurred that speculators were not responsible for oil’s big gains last year. Moreover, by curbing firms’ exposure to the market, the CFTC may end up actually reducing liquidity while doing nothing to prevent big price moves.

The real force at work behind last year’s run-up in prices, the subsequent decline and the rebound that has followed is the market’s invisible hand. In other words, good old fashioned supply and demand was the culprit. Unprecedented synchronized global growth between 2005 and early 2008 caused demand to soar, yet producers were unable to meet the call to increase production by anything more than a token amount.

As prices top $100 a barrel for the first time demand destruction was to be seen in the poorest nations in the world. Above $125 a barrel the pinch was being felt even among the richest nations. The global credit crisis brought things to a standstill, energy demand plummeted by several million barrels a day, and so did prices. OPEC responded by curtailing their oil production. In recent months growth has accelerated in emerging economies, and oil prices began to climb again.

Attempting to look for sinister price manipulation among speculators is mere scapegoating. It may make the finger pointers feel better, but it doesn’t get to the root of the problem: Oil is a finite commodity and the easy-to-obtain stuff has largely been consumed. Taking the long view, at $60 or $70 a barrel crude is maddeningly cheap. That doesn’t mean it can’t get cheaper in the short run, but with very little in the way of new supplies slated to come on stream in the coming years and emerging economies requiring every greater quantities, it may not be long before we look back and fondly reminisce about prices in the $60 range.

Comments

[ed233:]

If the carbon emissions proposal gains credence then I could easily see the price of a barrel of oil exceeding $200.00. Of course, a price approaching these limits would derail the tremendous growth potential of the emerging markets let alone damper the Obama economic recovery. Add to this an already bankrupt USA and you can easily predict a decade of decay for the American economy. LOL Looking after your money.

Jul 10 09:03 AM

[Stone Fox C...:]

Irrational Pessimism so far this month. Every indication is that growth is at last here and everybody runs around like the economy is falling apart. Agree that oil has like bottomed. Lots of commodity stocks reversed nicely today.

Jul 10 05:07 PM

[SageNot:]

Geez Steven, talking your book here too? Where do you live, in a cave or a secluded paradise? We're in the worst recession since the 1930's & you're worried about gold & crude oil? I'd tell you to WAKE UP; but I've done that before if you remember.

Dream on Steven, spinkle a little gold dust on your crude oil desert, it might be good for you.

Jul 11 11:25 AM

[Thomas MacLeod:]

Note the relationship between inflation protected treasuries and non inflation protected treasuries.......like WIP/BWX and TIP/IEF. The up trends are still strong. This suggests that the bond market is still expecting inflation to pop up sooner rather than later. This will be good for commodities. Obviously the question remains is the signal coming from the bond market stronger than that coming from the commodity market itself? I think the bond market is stronger and a leading indicator for the commodity market.

It looks like the dumbest thing to do as of the last 6 weeks (buying commodities) but if the behavior of the bond market is anything to go by it should be the right thing to do.

Jul 11 09:44 PM

[one eye:]

Mad Hedge: you have put the same Comment on 6 different Articles.

Its called Spamming.

Jul 12 06:20 AM

[Fighting Yoda:]

Oil is going under - you can't hold the price simply by cutting production and holding back inventories from the market (barges etc). This is the biggest worldwide recession with no end in sight - commodities will get hit a lot more. Chinese stockpiling and BRIC stories will not save the day.

Jul 13 12:39 AM

[Golden Oxen:]

All the markets are rigged, stock bond and commodities, this will only make it easier for the government sanctioned pools to have more clout by limiting positions of legitimate players.

Jul 13 07:57 AM

[schoolchildren:]

never known a TA that couldl think his way out of a wet paper bag. Still looking


On Jul 11 11:25 AM SageNot wrote:

> Geez Steven, talking your book here too? Where do you live, in a
> cave or a secluded paradise? We're in the worst recession since the
> 1930's & you're worried about gold & crude oil? I'd tell
> you to WAKE UP; but I've done that before if you remember.
>
> Dream on Steven, spinkle a little gold dust on your crude oil desert,
> it might be good for you.

Jul 14 02:05 PM