Remember this summer when it seemed like gas prices were on this perpetual escalator of rising prices? Goldman Sachs was reporting that oil prices were headed to $200. T. Boone Pickens was reporting that oil below $100 was far from likely. In hindsight, they were wrong and very wrong. Oil rose to $145 a barrel in late June and gasoline rose to $4. 75 per gallon. As quickly as oil and gasoline rose they fell even harder.Today, oil trades at close to $39 per barrel and gas is less than $1.80 per gallon.
The following paper will examine when commodities will bottom. To understand the bottom, the road to $145 per barrel will be constructed and then deconstructed. The oil bubble began with sound fundamental principles; in this case, it was the growth of the emerging markets namely China and a weakening U.S. dollar.
China was in the midst of preparing to show off their country to the world for the 2008 Summer Olympics. The event would highlight the years of growth and productivity, which helped contribute to the rising commodity prices. As the European economies strengthened and the U.S. was struggling with a housing related recession, the U.S. dollar lost close to 30% versus the Euro. The weak dollar played a major role in the ascent of oil.It was no coincidence that while oil reached all time highs that the U.S. dollar reached all time lows to the Euro. Unbridled enthusiasm started settling into the oil market in late May early June. Commodities were one of the only asset classes that was still growing, and major hedge funds began massively trading them. The hedge funds brought leveraging into play and generated the main catalyst for oil moving from $75 to $145 in the span of a couple of months.
The inputs that constructed the massive run-up in commodities are the same inputs that have deconstructed the commodity complex. Decoupling, the Euro, and leveraging have all taken a breather for now. Did the astronomical prices drive commodity producers to expand and overproduce? This is the fundamental question that needs to be answered first before the industry is safe to reenter. One metric that an investor may want to examine to determine demand and supply stability is the inventory level of commodity producers. A lazier way to figure out a reentry point is an appreciating Euro and a falling dollar.
The commodities market will bottom toward the first half of 2009. Currently many commodity producers are cutting back on production to prevent overproduction. Archelor Mittal the world’s largest steel producer is slashing production by 35% for the rest of this year. Likewise OPEC has announced production cuts for next year. With these production cutbacks coupled with the fiscal and monetary stimulus, the commodity complex should be ready for a rebound in late 2009.
2 comments:
In order to have prevented the ascent of oil prices, if the United States would have went back to some form of the gold standard, the dollar would have been stronger than it was during the housing crisis, which would have stop the oil prices' ascent.
From this reading, these massive commodity fluctuations seem to be the fault of the hedge funds. Perhaps placing some kind of regulation on these trades will help reduce the fluctuations, but that should probobly only be used as an emergency or last resort.
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