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How We Got Into This Mess (Energy Crisis Part III)

Presented by: Paul Schatz

As I mentioned before with bubbles in the past, the landscape has to be primed.  It has to be a perfect storm of sorts to endure.  In late 1998, the price of crude collapsed to only $11 per barrel.  Yes, you read that right.  Bottled water was more expensive than oil!  During the post 9/11 recession, after a significant rally, crude oil sank to just $15 per barrel.   

So, clearly, something dramatically changed the world in just a few short years. 

 

To begin, with price so low, consumers rarely gave much thought to their behavioral patterns.  They just kept buying those gas guzzling SUVs as commutes to work grew longer and longer.  Winter thermostats were kept much higher than needed since it just wasn't than costly to keep toasty.

 

I vividly recall locking in our heating oil price in early 2002 at 79 cents per gallon for the next 12 months.  I only wish that could have been 12 years!

 

With stocks in a long-term bear market at that time and the economy in recession, Greenspan & Company pushed interest rates down to historically low levels, and kept them there for an abnormally long time.  This resulted in a long-term bear market in the US dollar. 

 

Since the energy complex is priced in US dollars, very low rates punish the dollar, thereby pushing up the price of oil and other commodities.  Adding to that was the increased energy demand from emerging countries like China and India

 

At the same time oil prices began to march higher, our government made a tactical decision to fill the Strategic Petroleum Reserve, which essentially stores enough crude oil in western salt mines to ensure US demand for at least a year.  Just think about the enormity of the US government placing buy orders in the crude oil pits for years on end!

 

Moving on, Wall Street saw the huge potential for commodity related exchange traded funds, ETFs.  These work very similarly to the popular SPY and QQQQ, giving non futures related access to almost every investor.  

 

While Wall Street created a massive meal of commodity derivatives for the world to eat, many pension funds decided to increase their allocations to the asset class.  Now moving the commodity weighting from 2% to 8% doesn't seem like much, imagine if you are running a $50 billion fund!  And think of all the public and private pension funds who openly expressed their desires to increase commodity exposure!

 

And with Wall Street and the pension funds diving in head first, they were not playing the same game as other investors.  You see, in the commodity markets, their used to be very firm rules on exactly how much of a given commodity you could own.  The reason being, so no one entity could corner the world's supply, like the Hunt Brothers tried to do in silver almost 30 years ago.

 

In today's case, somehow Wall Street and the pension funds were given exemptions from standard positions limits, along with being able to "hide" from various reporting requirements.  So while the rules prevented an energy company from acquiring too much of an asset, they allowed the financial folks to do just that!

 

Can you now understand how we got to where we were in July?  It really did take the perfect storm to prime that pump.  Along the way, as the final leg higher in energy began, every single Wall Street firm was positive on oil, similar to how they were on technology in late 1999 and housing in 2006.

 

And when my forecast that the energy bubble would not last was so easily dismissed by a well known expert during a TV interview on CNBC, I had a pretty good feeling that the peak was getting closer in time.

 

Energy bears were in very short supply and the public appetite for energy stories grew immensely.  As I have mentioned before, on June 18, the television show Black Gold, which chronicles the lives of oil workers, was launched. 

 

That eerily reminded me of the two shows that began in 2000, one focusing on the soap opera lives of Wall Street investment bankers, and the other on the wild times as a Wall Street trader.  If you recall, the timing coincided with the beginning of the worst bear market in 30 years.

 

And just last year, two shows that I enjoyed very much, Dirty, Sexy Money and Big Shots, both focused on money, greed and extravagance as the economy and bull market were peaking.  So, by the time a given theme really reaches Main Street, more often than not, it's about to reverse.

 

I eagerly await a show based on the foreclosure market to signal the ultimate bottom in housing!

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