Wednesday, March 26, 2008

this doesn't happen in the text books


I don't know whether this is in a textbook, but it sure seems like it every time you talk to a trained financial professional or economist. they all believe energy prices will fall if the US enters a recession.

this seems fair, because it's often been the case. for instance, the chart above compares US durable goods orders to oil prices. they tracked each other 80% of the time over the last decade. but over the past year, they have a -0.2 correlation, according to haver analytics. that means they move in the opposite directions.

so, right off the bat, we know that we're in a world not covered by standard understandings of economic cause and effects. india and china's new middle classes will demand things, and get first dibs owing to their stronger currencies... that will make imports more expensive, and make some of our own home-grown products like food more expensive to us. we're no longer the driving force behind commodity prices.

over time, it will only move further in this direction. the emerging markets might very well continue to grow just as the US did 120 years ago. if that happens while our own economy is slowing and getting dragged down by debt, the dollar will continue to fall, hurting our purchasing power. (this is why in my previous entry, I urge the creation of a new non-oil economy that creates jobs for americans rather than filling arab pockets.)

so what's going on with oil? it's probably overvalued according to the traditional norms in the commodity markets, where worries about bottlenecks and shortages have typically controlled the market.
but let's think about oil from an equity investor's point of view: we already know this breed of investor will pay extremely high earnings multiples for companies like ISRG or RIMM because they have a very high confidence they will deliver on their growth. right now, all the evidence seems to point towards strong demand and relatively limited supplies of oil over the next several decades. in fact, it's pretty close to certain it will be in high demand.
we're starting to see oil priced according to the imagination of individual investors who see a world where oil remains in strong demand because new supplies become fewer and farther between. until that vision leaves their minds, these commodities could remain strong.
unlike the traditional commodities market, of which I know almost nothing, the buyer of stocks is a long-term holder. money in his ETF will get recycled from one futures contract to another. I would think this would dampen price moves for the spot price.

the stock investor knows that long term, oil HAS TO be worth more. sharon epperson on CNBC and others have been saying that there is a new kind of valuation being placed on oil. hedge funds seem to have discovered it back in early 2006, before it sold off. things like this may explain why someone like boone pickens changed his mind about oil, and why other experts have underestimated its strength. this trend will continue.
now that stock investors can buy commodities via ETFs, it's an entirely different world.

this use of oil as a long-term store of value seems to be real. I imagine it will remain between 100 anf 110 for several months before breaking out to the upside.

this also produce results that then push oil prices even higher... consider this:

last night on charlie rose, the president of shell warned that urban areas with lots of cars could suffer violence and unrest as people lash out against high gasoline prices. this guy clearly has an agenda, because he was trying to use the needs of american consumers to justify drilling in ANWR. so, he did have a vested interest in making that claim. but, it's still a pretty strong statement from a corporate executive.

after all, if you're a low income american with a family and a car, you will have a problem with surging prices and a slowing economy. this angst and frustration will play out in millions of homes across the country as people learn to do with less. of course, if social disruption occurs, it could probably trigger another bull run -- although at that point you wonder if the government wouldn't release some from the reserve.

so far, there aren't any documented cases of actual violence resulting from high oil prices this yet, but I did find a few cases of how it's having a negative effect...

a food pantry in WV http://wowktv.com/story.cfm?func=viewstory&storyid=36460

and reaction in wisconsin: http://www.lacrossetribune.com/articles/2008/03/25/news/01lead.txt

and angry police in ohio:
http://www.wtov9.com/news/15580934/detail.html

it's worth watching.