Monday, June 30, 2008

Oil, Maybe it is speculators...

Oil has continued its march to levels above $140 a barrel. This translates into a national average gas price per gallon of >$4.00. Many are looking to blame someone for the rise in oil's price, and there is no shortage of suspects. China and India, and other emerging economies, are to blame certainly for increased demand. Some blame OPEC and hope that increasing output will reduce supply constraints and take some pressure off the price. But lately, speculators have been blamed. At first I was skeptical, but there is one plausible idea to this latest theory that oil is currently an asset bubble.

The US market is down, and returns will be challenged as they return to more historic levels going forward. So as money comes off the table, investors need to put it somewhere else. Obviously, the likely bet may be oil, since the expansion of all emerging economies rely upon oil. Commodities are a good inflation hedge as well, and since the Fed has turned hawkish on inflation, oil and other hard assets might be where investors flock.

The initial Tech bubble that popped in 2000 forced investors to bid up the next "great thing" which was the mini-asset bubble in biotech, that then turned to the housing/credit bubble. Therefore, as the US markets fall, the money gets rolled forward to the next respective asset bubble. Again, many think the price for oil and other hard asset commodities like corn, platinum, etc. are being bid up as a bubble since other alternatives offer less attractive potential returns.

Let's be clear about something. You and I can speculate on any given stock, and hope that we get enough critical mass to move the price beyond it's intrinsic or fundamental price (i.e. what it's truly worth), or at the very least, moved to a price beyond what we paid for it. But at any given time, we could potentially move our money to another stock as a substitute once we believe the stock has gotten overvalued to take our profits before others start selling. Owning GE's stock gives me the rights to that companies future cash flows; it's basically a receipt to "GE's future cash", and once the price gets out of whack, we might get out because we know the price is "too high". But oil is a hard asset, and there is no substitute. If oil's price rise is based upon speculation of further upside moves, there's nothing else investors can switch to right now per se that by doing so, would reduce demand for oil and thus drive the price for oil down.

Finally, if you think the run up is bad now, think what the price may get to if the mid-east suddenly becomes destabilized.

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