Energy... Passing Fancy Or Here To Stay? (Energy Crisis Part II)


Energy... Passing Fancy Or Here To Stay? (Energy Crisis Part II)

In part I of the Energy Crisis, I opened the discussion about the overall behavioral differences between commodities and equities in general.  You would have to be either living under a rock or asleep for a few years not to notice the dramatic rise in energy and food prices from 2002 to mid 2008. 

Lots of folks have emailed, asking me if I thought these high prices were here to stay or only temporary.  As I mentioned in the last article, commodities tend to run in very sharp upward spikes and then spend much more time doing nothing.  Before these major rallies occur, commodities get very quiet with extremely low volatility as they "scrape" along the bottom. 

Then, in grand fashion, they begin a meteoric rise with returns way north of 100%.  Like the dotcom bubble of the late 1990s, the commodity move exceeds most people's wildest expectations with prices literally running up the side of the page to a crescendo or parabolic peak.

It is then and only then that the bubble begins to burst in the same grand fashion. 

So the short answer to the popular question is that I do not believe the energy, precious metals or agriculture boom is here to stay.  Just like I did not believe the housing boom and dotcom mania would last either.  Rather, this looks like many of the past bubbles where it takes the perfect storm to establish them, perpetuate them and finally, collapse them.

To me, as in the past, the current commodity chase is more about psychology than anything else.  It wasn't long ago when we were told by the Wall Street pundits that it's about eyeballs not earnings!  And it's the same thing now.  Literally, all of a sudden, we're hearing about food shortages, riots, peak oil, etc., as if we suddenly woke up to a new world order.

I don't buy it. 

Let's turn to energy, specifically, for a while.  It wasn't long ago when the price of a barrel of crude oil was in the teens right after 9-11.  I don't know a single person who was warning of peak oil or a surge in demand from the emerging economies back then.  We had all the cheap oil we needed and no one was worried.

Just 7 short years later, we are now panic stricken about running out of cheap oil.  Sure, things have changed.  But, I do not believe for one minute that those changes warrant a move from the teens to almost $140 per barrel as "permanent".

As I mentioned above, you really need to see the perfect storm to set up such a mania.  Just think about how many things had to come together in order to create the biggest housing bubble of this generation. 

It was combination of a bear market in stocks, extremely low interest rates over a long period, little or no regulation in mortgages and the Wall Street "geniuses" engineering financially irresponsible instruments.  The exact same storm was seen in the late 1990s with the dotcom bubble.

So with energy, let's examine the current perfect storm.  First, given how cheap oil was for so long, we have our addiction to the product.  That's been there since the early 1980s.  Next we have increased demand from emerging countries like China and India.  Let's not forget about the collapse in the U.S. dollar, which is the currency of oil.

As the commodity boom was underway, there has been a sea change by institutions to include indexed and managed futures in their investment allocations, creating a new wave of demand.  At the same time, the growing ETF market moved into commodities with a proxy for oil, USO, coming to market.  As with the pension plans, this really increased demand for the underlying consumable.

Lastly, as with any mania, we have our speculators who are being unfairly blamed for the surge since $100 a barrel.  I say "unfairly" because no one was giving that group credit when prices were driven into the ground for years and years in the late 1990s and early 2000s. 

I believe speculators (specs) are necessary and healthy for the financial markets, all markets.  They provide liquidity (more players and more dollars) to keep an orderly flow in the market.  Since they usually just follow trends and jump on towards the end, speculators are not considered the smart money.  In fact, it's the smart money that usually sells their position to the specs.

With all those factors thrown into the mixing bowl, we have quite the recipe for the current energy bubble.  Will it end?  Absolutely!  With fireworks like we normally see only over July 4th.  When is the billion dollar question.  About the only thing I can offer is that we are getting much, much closer each day in terms of time.

Price may be a different story.  We may see crude peak right here in the 130s or 140s or 150s.  But when it does, you can look for an initial waterfall decline to get the ball rolling.  You will see mass liquidations by the specs as brokerage firms quickly raise margin requirements, the money you must have on deposit before you can trade.

Commodities are the only instrument I can think of where a guaranteed "cure" for high prices is higher prices.  The more vertical gas and oil go, the quicker alternatives will be found, not to mention that demand will certainly decline. 

Think of how many folks turned their thermostats down last winter when prices began to surge.  I know we did.  We also added more insulation and sealed up cracks.  Think of how many families no longer take two cars out for routine errands.  I know in our case, we would have no problem taking the family to visit friends in Vermont or New York on a whim.  With gas over $4, I am in no hurry to spend hours on I-91 or I-95!

As I am thinking faster than my fat little fingers can type, I also just realized that almost every Wall Street firm is no positive on energy.  If that isn't the perfect contrary indicator, I don't know what is!  It's the eyeballs over earnings issue all over again.  Remember Henry Blodgett, Mary Meeker and Jack Grubman?

Finally, on June 18 at 10pm, a new reality TV show premieres called Black Gold, which chronicles the life of workers in the oil industry.  As if all of a sudden, it’s become this glamorous career!  Did you just hear the DING, DING, DING of the bell ringing, signaling THE top?

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