Recently, the government--pressured by Congress--disclosed a probe into potential oil market manipulation. The politicians want to show they’re doing something about high gas prices before the presidential election.
Billionaire oilman T. Boone Pickens called the efforts a waste of time.
You have 85.0 million barrels per day of oil available in the global energy market and 86.4 million barrels per day of demand. So the price of oil is going to go up until you can kill demand.
On the other hand, global financier George Soros told us the big funds are skewing prices.
The institutions are piling on one side of the market and they have sufficient weight to unbalance it.
Who’s right? Is this probe another waste of taxpayer money? You bet it is. If they let the free markets do their work, the issue will eventually work itself out.
The politicians need to understand that this is a global market. An oil importer, such as the US, can’t dictate the price of oil, which comprises three-quarters of the gasoline price.
What about the speculators? From the May 22 high to the June 5 low, the price of oil collapsed nearly $14. That’s a drop of about 10 percent.
Were the evil speculators pushing it down during that period? May 29 the market was up more than $5 a barrel. The truth is there's no single player--consumer, producer or trader--who can independently dictate the price of oil.
These patterns of spiraling prices historically have never lasted. All spirals eventually end, such as the silver spiral during the late 1970s and early ’80s, when ridiculously high prices made $50-an-ounce silver seem uneconomic. It ended with a vengeance.
Again, there has never been a market at any time in history that has run up in a straight line like oil has recently. This, too, shall pass. The only question is when?
Demand in the US is falling, and certainly there will be sharp, deep price breaks. However, demand in China is rising. Take a look at an excerpt from this week’s issue of Mary Cashman’s Energy Market Intelligence.
Rising Chinese demand is pushing up oil prices even at $130-a-barrel levels. The increase in oil prices is not a bubble but is based on demand-supply imbalances. China requires diesel to run its quake-hit power plants, as many of the working power plants are cut off from usual supplies of coal due to the earthquake. Also, many power plants suffered damages during the earthquake forcing people to use diesel generators.
Let’s briefly discuss the fundamentals that lead me to believe this current bull market in oil (as well as a host of commodities) isn’t a bubble and that--despite the inevitable corrections--it will likely last for quite a while longer.
We know there’s explosive demand growth in the developing world with no easy way to turn this train around. More than a billion consumers are moving up into a higher level of consumption, demanding the comforts the West has enjoyed since the third Industrial Revolution that began in the early 1900s.
For many decades now, 1billion of the earth’s human inhabitants have consumed two-thirds of the earth’s developed resources. The other 6 billion got by on the remaining third. Now, led by China and India, the developing world is eating better and living better. And this requires massive commodity consumption, with oil topping the list.
These people are transitioning from being mainly producers to a combination of producers and consumers. This puts upward pressure on commodity prices. The magnitude of this unprecedented demand shock is difficult to comprehend as people drive more cars and consume more electric power.
Heating, lighting, air conditioning and appliances require power plants. So do new buildings, roads, ships, ports, trains, trucks and buses. And the list goes on: energy needs, food requirements, textiles, copper to build new electrical grids, corn and soybean meal to feed growing populations of pigs, chicken and cattle. Soybeans, cotton, rice, sugar and corn for food and fuel with more fertilizer needed to grow these crops all consume a significant amount of energy.
The global population is growing by 80 million people annually. This is the equivalent of adding the entire population of Mexico to the world each year. The areas of the world with the greatest population percentage increases are moving toward the consumption patterns of the developed world.
And while all this takes place, the developed world continues to consume. And it’s not just India and China that are players in this industrial revolution. There are the other rapidly emerging Asian nations, Eastern Europe, Russia, Brazil and other South American nations all creating massive new consumer middle classes. But let’s concentrate on Asia for a moment.
As we go to press, the average American is using approximately 25 barrels worth of oil annually. To put this number in perspective, at the conclusion of World War II, when the Japanese economy was in ruins, they consumed the equivalent of 1 barrel per capita annually. Now that Japan has become a modern, industrialized power, the average Japanese consumes approximately 17 barrels of oil annually.
A decade ago, the average Chinese consumed about 1 barrel annually, and now this number is rapidly approaching 2 barrels a year. What happens when this number doubles again, and then quadruples? As T. Boone Pickens told us, on a daily basis, the world uses all the oil it can produce.
To put it a different way, in America we have about 900 cars for every 1,000 people. By comparison--this number is constantly growing and will no doubt be outdated by the time you read it--only 40 people per 1,000 own cars in China. If vehicle ownership doubles to 80 people per 1,000, how will this affect the demand for aluminum and rubber in auto manufacturing, let alone oil?
As we know, a large percentage of global oil supplies are produced in volatile places. China is an oil importer, and as its oil consumption grows, what happens every time there’s a disruption because of an outage, pipeline problem, hurricane, war or some political event in a producing country?
Chinese per-capita income has risen from less than $500 in 1990 to $3,000, while Indian per-capita income has risen from less than $500 in 1990 to more than $1,000 today. This stimulates energy demand, not to mention demand for more higher-quality food, which also requires more fuel to produce. And what about food?
North American farmers have experienced great growing weather for most of the past 100 years. This, combined with improvements in agriculture, has resulted in abundant crops. You have to go back 800 years to find a period of such favorable weather for such a long time.
However, as this year has shown, we know what can happen to the price of wheat. For example, if there are just a few crop failures around the world, prices can easily triple. Considering how fair weather has generally been over the past two decades, food stocks in corn, wheat, soybeans and rice are dangerously low.
With a new Mexico being added to the world’s population each year, the demand side of this equation isn’t going to solve this problem. With global warming an impending dilemma for crops, can the world continue to rely on the supply side growing? When the world experiences another year of poor weather--whether too much rain or too little, too cold or too dry--food prices are set to surge again. Last week, soybean prices surged because too much rain hampered planting efforts.
This leads to the question many of you are asking: How can I profit from these longer-term trends?
Fundamentals are important because they set the tone and basis for commodity price moves. However, increasingly in this electronic age, fundamental analysis won’t help you in shorter-term trading. The fundamentals for many of the markets we trade are complex and, often times, conflicting. With that in mind, realize it’s virtually impossible for an individual to be able to sort through the thousands of statistics to accurately determine the direction oil, or any commodity, will move today.
Many traders have wondered why something like this happens; on the day it was announced, the crude oil supplies went down an extremely bullish 9 million barrels in the weekly report, and the traders were looking for an increase. So how could the market close lower?
This happened just last week. Apparently, there must have been some hidden, evil fundamental lurking that caused the crash. The fundamentals for oil--or you can substitute your favorite commodity here--are complex. On any particular trading session, assembling all the supply/demand data bits into a trading strategy is impossible. Still, there’s one dominant fundamental that you can analyze to achieve profitability.
Soros once wrote, The most important fundamental is credit flow. Or, to put this more simply, money is the key. Money flows are what moves markets, and this is the most important determinant of price action. My premise is that you really only need to successfully analyze one fundamental to do well: determine which direction the money is flowing.
In essence, our topic is as old as the hills. Commodities are necessary for life and will continue to trade as long as the human race exists. Every economy has experienced long periods of negative growth when commodity prices were depressed, and some--sugar for example--are today.
Then there are the bull cycles. At some point, oil use will be replaced by some alternative energy source, but the macro trend of accelerating commodity consumption will likely continue unabated. More important, the trend of accelerating power usage will continue, and the new challenge will be avoiding power shortages. There’s no quick solution to electricity shortages, and I anticipate this will become a growing problem as global power demand accelerates.
The current global bull commodity cycle is about a decade old. Mini cycles, such as the commodity decade of the ’70s, lasted about 10 years. However, longer-term charts beginning from the 1700s tell us major bull cycles in commodities generally range from 18 to 23 years. One example: During the turn into the 20th century, the last Industrial Revolution lasted nearly 30 years.
How long will this one last?
Beats me. However, I anticipate commodities will continue to be hot for years to come because the world has entered a period of tighter commodity supplies with increasing demand. The planet’s resources are limited, and commodities can play a role in your asset allocation decisions. Just remember to follow the money flows.
And, finally, it would be good if politicians around the world--many artificially subsidize the price of gasoline, so that there’s no incentive to curb usage--would allow free market forces let the price of gasoline seek its own natural level. It this was the case, the free market could ultimately solve this problem for us.
Innovative, new products are only a few years away. New technologies, such as the Concept Chevy Volt, are exciting innovations for the future of America and the oil importing world.
In the meantime, I’ll design my specific trade recommendations for my trading service, Futures Market Forecaster, to help you follow the money flows.