No one knows where oil is heading.
Only four months ago (May '08), oil
cleared $120 a barrel on its way to $145. Within a month, analysts were
calling for $150, even $200 oil. Countless graphs and charts surfaced
showing how demand was outpacing supplies. Pundit after pundit commented
that emerging markets like China and India were fueling an unstoppable
mega-boom for black gold.
Then Russia invaded Georgia, and oil
took a nose dive falling more than 20 consecutive days from $145 down to
$115 a barrel. Hurricane Gustav gave it a brief shot in the arm, but the
damage was less than expected and oil rolled over the next day.
Now analysts are predicting oil will
fall to $100 or even $85 a barrel. Again the charts and graphs are
surfacing, this time showing that both international and domestic demand
for oil is slowing down. Phrases like "decreased US demand" and "global
recession" are being tossed around, just like "emerging market demand"
and "ChIndia" were being hurled a few months ago.
So is oil going to go up or down?
The honest answer is that no one has a
clue. We can talk all we want about worldwide supplies, Brazil's latest
discoveries, potential drilling in the US and other factors. But the
reality is that an enormous slew of conflicting issues affect oil prices
today. Among the more glaring are:
Geopolitical Issues (Israel vs. Iran)
(Russia vs. Georgia/ the West).
In the last three months, Israel has
begun running test bombing campaigns to areas that are the same distance
from Israel as Iran. Similarly, the US has sent three battle cruisers to
the Persian Gulf. Should either of these countries actually bomb Iran,
oil is going through the roof.
Then there's the situation with Russia, which is quickly turning into
Cold War II. Reports are showing Russian bombers flying over Northern
Europe, the Kremlin threatening to supply Iran with missile defense
systems, and Vladimir Putin threatening outright confrontation with the
West in the Black Sea. Should Russia and the West seriously go
head-to-head, the Kremlin could turn off the oil tap, pushing prices
into the stratosphere. Russia's already turned off energy supplies once
in the recent past: see Ukraine 2006.
Speculation
Whether you believe in the "evil"
speculator stereotype or not, the commodities markets are dominated by a
handful of players. The Commodities Futures Trading Commission recently
discovered that just four swap dealers-like commodity brokers-controlled
one third of all long oil contracts in July. At one point, one
particular trader accounted for an incredible 11% of the oil trading
market. These kinds of heavy bets are what wipe out huge amounts of
capital in an instant (think the Amaranth hedge fund and its $6 billion
in losses from natural gas futures). Small surprise oil is making such
large choppy moves day to day.
The Over-Leveraged Financial System
Institutional trading models and
systems are dominated by linear relationships (euro vs. dollar, dollar
vs. commodities, commodities vs. equities). There are literally
thousands of traders following these patterns. When one of their models
is triggered all of these guys pile into or out of a given investment.
You can see this on a day-to-day basis. Typically, whenever oil rises,
stocks plunge and vice versa (yesterday's action when oil AND stocks
fell is truly worrisome).
Throw in a lot of leverage-investing with borrowed money-and you've got
herds of guys who will dump a position if it even looks like it's going
against them. Just look at the action of the last two months where
stocks rallied 1+% in one day only to give up all of those gains and
then some the next. Almost every time oil was on the other side of that
trade, rising when stocks fell and vice versa.
All of these factors collide in the oil
markets. And they make forecasting oil's moves virtually impossible.
Could oil go to $80? Sure. But one bomb in Iran and it'll be over $150
in a matter of days.
Similarly, oil could rise to $130 on
concerns of a conflict between Russia and the West, only to plunge when
an Amaranth-sized hedge funds blows up and has to liquidate its
portfolio in a matter of moments.
Beware anyone who has a "certain"
opinion on oil. When it comes to investing in black gold today, only one
thing is certain: you need to be very nimble OR have a very high pain
threshold. The oil markets have no sympathy for opinions, no matter how
informed they are.
Best Regards,
Graham Summers
