Trading
Tip
 Oil
and Gas – Crudely Speaking Part
VIII:
More Fundamental Considerations
by
D.R.
Barton
In the short-run, the market is a voting machine; in the long-run, the market is a weighing machine.
--Benjamin Graham
We begin to wrap up our series on oil and gas this week with some additional thoughts on fundamentals and then a quick look at a current chart that is truly stunning.
Thanks for the e-mails that you sent. Most talked about fundamentals of the market and how, regardless of what’s happening now,
the fundamentals of supply and demand will dictate price.
I agree – in the long run. Like Benjamin Graham said in our quote today, in the short term, the market is a voting machine. Or a subjective beauty contest. All of these analogies are provided to say that at any given moment, the whims of buyers and sellers dictate the price of the moment. In hindsight, we can often see where buyers have gotten overly enthusiastic (manias, bubbles) or where sellers drove prices to unrealistically low levels (extreme value periods).
But those periods of exuberance are very difficult to identify in the moment! For example, Wall Street was littered with folks talking about the Internet bubble – in 1997 and 1998, let alone 1999. Some who acted on the courage of their convictions lost fortunes shorting into the top; others merely lost face.
Indeed, calling market tops (or bottoms, for that matter) is a treacherous game, at best. The perils of timing tops is best summarized by John Maynard Keynes who famously said that markets can remain irrational longer than we can remain solvent.
This brings us back to the oil markets; in two or five years, we may look back and say that $145 per barrel was a bubble or mania price. OR
we may look back and say that it was the right price on the way to $200+.
In 2000, there were competent analysts who said that Internet stocks were properly priced because there was a new market model taking over. And almost all institutions and individuals agreed, voting with their dollars in the stock market. Of course there were other competent analysts that had the opposite view.
Today, in the oil market, there are also two camps. And in the heat of the moment, it’s almost impossible to discern who’s right. The peak oil/limited supply camp, argues effectively that global oil production will begin to decline at some future date and that the current prices reflect this view. Others make valid arguments that temporarily higher oil prices will bring on new spending that will lead to technological advances making it easier/cheaper to extract existing oil deposits and those that are hard to reach (or find). This, in turn, will increase supply and drive prices back down.
For now, the markets participants are voting for alternative “A” and prices are hovering at all time highs. And it’s impossible to know how long the “weighing phase” will take.
When will we know “the fundamental fair price” for a barrel of oil?
One can argue that it will take much longer than figuring out the Internet company valuations. In the Internet company case, those companies were publically traded and information was mostly easy to access. In the case of oil reserves and production numbers, solid information is much harder to come by; a majority of the world’s known reserves are controlled by state-owned entities who only have to disclose what they want.
This makes the puzzle all the more difficult to piece together. Let’s jump back into some details to see just how multilayered the oil pricing problem is.
Last week we talked briefly about commodity fund indexing by large institutions, which has grown 20 fold in the last five years, according to
Barron’s.
Here is a striking chart that shows the magnitude of what’s been happening in
the crude market:
To be honest, when I looked at the chart for the first time this week, I was shocked.
The volume of crude oil futures contracts traded today is more than 56 times greater than it was four years ago! And dollar volume of crude oil futures traded has increased by 222 times. That’s a 22,000% increase! It boggles the mind.
In our next oil article, I’d like to take a look at energy market speculation and why government intervention in that area is a very bad idea indeed.
One final note (erratum for last week’s article): the levels listed on last week’s charts were clearly areas of support and were mismarked.
Please keep those comments coming to drbarton “at”
iitm.com.
Great Trading!
D. R.
About
D.R. Barton: A
passion for the systematic approach to the markets and
lifelong love of teaching and learning have propelled D.R.
Barton, Jr. to the top of the investment and trading
arena. He is a regularly featured guest on both Report
on Business TV, and
WTOP News Radio in Washington, D.C., and has been a guest
on Bloomberg Radio. His
articles have appeared on SmartMoney.com and Financial
Advisor magazine.
You may contact D.R. at
“drbarton” at “iitm.com”.
|
