Dr. Stephen Leeb's  Instablog

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.

Yesterday 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.

Yesterday 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.