Time to Short Oil Due to Excessive Speculation? Think Again

It's weird how normal $100 plus oil suddenly seems. Oil has gone parabolic, and this chart from Bespoke Investments seems to suggest that things could be getting toppy.

Speculators are not very popular right now. Futures trading in many commodities across the world has been banned. Numerous experts have spoken out that most of crude's price today is due to "speculation" and a "strong inflow of funds". Indeed, I came across this interesting article where an analyst was commenting on the rampant speculation in the oil space:

Fadel Gheit, an oil analyst at Oppenheimer, said record-breaking prices are a result of pure speculation by hedge funds and commodities traders, not a result of negative market fundamentals, adding that there is no real supply shortage.

"But rumors and speculation have taken over the market," said Gheit. "For example, even if the oil company is shut down, which Russia would not allow, they could maintain their current export volume, because they are limited only by capacity, not by production. And Russia has plenty more oil waiting to be exported."

Before you run off to double your short positions, check the date. The article was published way back on August 2004. The path of least resistance has been consistently up these past few years (even with a 40%+ price correction like we had in 2006). That price action needs to be respected. While oil may very well go down in the event of a global recession, it could also double in between.

Speculators play an important role in price discovery, and just because speculation is rife doesn't mean that prices are unstable and headed down. Speculators are trend followers, not trend creators. Judging by what the strategists are saying, we may end the year up. (Goldman Sachs is now forecasting a second half price of $141 and a super spike price of $200). Marketwatch has this article with Outstanding Investments predicting $140 oil.

Trying to time the change in a multi-year trend line is risky, especially one that's hitting a new 52-week high seemingly every week.

Full Disclosure: No positions

Comments

[Eric Fox:]

Don't forget this part of the article from 2004:

"U.S. oil demand is up 3.5 percent so far this year, despite climbing prices, and overall U.S. consumer prices fell for the first time in eight months this July. Analysts say this indicates that underlying inflation pressures are largely under control, despite emerging signs in other major economies that rising energy costs are starting to take a toll."

You can bet that demand in the U.S. will not be up 3.5% this year.

2008 May 22 12:13 PM

[User 68127:]

Sajal,
Some people were early in calling the tech and housing bubbles, too...doesn't mean they didn't happen...

2008 May 22 03:43 PM

[Kunst:]

Mr. Hudlow: How come you can't even spell your first name: "Graqnt"

You have now entered the stupid zone.

SA, can you cut this guy off before he wastes any more bits?

2008 May 22 08:08 PM

[Sajal:]

Eric,

Good point. But remember that fuel subsidies in India and China distort the supply-demand picture. The fuel consumption in the emerging markets is insensitive to the oil price, and should go up this year as well, scaling with the GDP growth story..

-Sajal

2008 May 22 09:18 PM

[maher:]

Oil is spiking due to the real potential of a naval blockade of Iran, and/or strikes on Iranian regime terrorist bases

2008 May 23 01:17 AM

[fxtrader07:]

the author obviously completely missed the point made in a must-read presentation made this week before the u.s. senate committee on homeland security regarding the massive build-up of commodities investments by long-only, price-insensitive index speculators like pension funds:
hsgac.senate.gov/publi...

these people may not create an uptrend - long term, the uptredn for commodity prices is there anyway, at least in nominal dollar terms. But they can extremely spped up and exacerbate this trend given the relative miniscule size of the world's commodities markets.
so while i am convincedn of oil reaching well above 160-200$ longer term, this years spike by over 35% in just 5 months is very much driven by artificial additional demand.
talk about crude oil etfs - people buying this stuff should not complain about $4 gasoline - because they helped to add additional demand in crude in the first place. to be clear: i do not blame them - it is as good a hedge as it gets. but they have simnply no right to complain about rising oil and gas prices as they are helping their rise.

2008 May 23 03:36 AM

[ArtfulDodger:]

A much more important article reporting the scam going on regarding oil supply and demand was written by Philip Davis, who is a scam exposer extraordinaire.

His is a great and badly needed article!

See here: seekingalpha.com/artic...

Rebeldog

2008 May 23 10:55 AM