Wednesday, May 30, 2007

Incoherent Ramblings On Commodities

Well, I started to type this a handful of days ago and ran out of time. I was going to say that gasoline prices were likely going to drop after Memorial Day. They did. Let's see how far. I am looking for a confirmation of a lower high in oil over coming months. Crack spreads are ungodly high and it is solely because of trader euphoria. Yes refinery capacity is high but shortages? Come on. If I saw lines at the pump and rationing, I'd say gasoline would have a valid economic reason for being where it is. (Crack spreads are simplistically the margin companies receive for breaking oil down into its refined products including gasoline.)

I am bored with the social engineering of Hubbert's Peak and gasoline refinery problems as excuses why energy prices are so high. There is zero evidence that we are running out of oil. We may some day but we have more oil reserves than at any time in history. That is after we have used all of the oil known to exist in the 1970s. Based on knowledge available then, we shouldn't have any oil. In other words, it's the same old paranoia and reason for Wall Street to jam commodities. There is an interesting argument put forth by a NASA scientist that may imply the planet's carbon energy supplies will never be depleted. Some time I'll post more on that. Gasoline shortages are what we saw in the 1970s when there were long lines at the pump and rationing. Ever had any problems over the last five years getting gasoline regardless of where you live in the world? Even in Nigeria where rebels supposedly threaten my ability to fill up at the pump? Did you know global demand growth for oil has risen about 3% per annum and we've seen oil rocket many times higher. Yet, in the 1950s, global demand growth was 9% and we didn't see this environment? Or as I read recently, President Carter told us we were going to run out of oil and a few decades later it was bout $10 a barrel? (My indifference to political babble must have started at a young age because I don't remember.) Group think can be a very powerful phenomenon. Is it really different this time? I'm extremely dubious. Especially since we now have more excess oil in the system than we did when oil was $15 a barrel. Now, that said, oil may be one of the most reasonably valued assets in the world. Considering a Starbucks Tall Frappuccino equates to about $1,500 a barrel and oil is $70 a barrel with economic value, I'd be more inclined to ride the oil wave up and down until we break this cycle as opposed to buying Starbucks' stock. (That is the likely reason oil is inflated in a time of very high global risks, oil has become a "safer" haven.)

Regardless of whether we've built new refineries or not, the markets will eventually punish the crack spread expansion that is totally unsustainable. $40-50 this cycle based on fundamentals? Maybe. The rest is likely Wall Street or OPEC or both in the futures market. I tend to believe that it is Wall Street as energy companies have complained to Congress of distortions in the futures markets from hedge funds. (An interesting Congressional report on hedge fund manipulation of the oil markets from 2006. Google it and it might still be out there if you are interested. I read it a long time ago and couldn't find the URL on a quick search.) Statistic after statistic on the number of CTAs trading energy, the amount of energy contract expansion, the alternative investment crowd pushing pensions into commodities, etc. Now, all of this said, the rumblings out of politicians to tax energy company profits is not a good thing. It's noble to want to make the world a fair place but we've seen this replayed time and again. What is fair? Do you want politicians deciding what is fair? The same ones capable of bungling nearly everything they touch? US financial profits are about seven times energy company profits. Do we tax the banks for making too much money? Or hedge funds for charging exorbitant fees? Markets will eventually figure it out. Maybe next politicians can decide if your kids go to college or not because of what is fair. Or decide if you live or die based on the cost of medical treatment? Capitalism is not democracy as I have written before and needs a framework at times to prevent those that would run over everyone else in the name of power and greed. Why not provide a market based incentive for energy companies to invest their capital in green technologies or a market based incentive to foster competition with oil? Competition and market based systems work better than taxes which have unintended effects.

While it seems as though Wall Street has done a reasonable job of convincing society that commodity price rises are from Chinese demand, and that may be partly true, Wall Street is printing money off of these commodity moves. So, is that all bad? Well, Wall Street has become rather excessive but that too will pass. But, it is mostly American and European firms playing in the commodity trading patch. That is wealth created in Europe and the US. Both are able to digest higher commodity prices comparatively. So, these profits may find their way into future innovation, new technologies and private investment years down the road. Thus, eventually creating sustainable wealth in other industries. In other words, emerging markets need commodities and regardless of where they come from, European and American firms are making a killing off of their consumption. The same thing is happening with the large commodity trading firms playing in the global agriculture market with those commodities. American firms are making a killing off of high agriculture prices and not the local farmers in emerging markets. All of this is bad for emerging markets. This begs a question. Are emerging markets really ready to compete in a globalized world? Seriously? I am starting to question the sustainability of globalization in its current form. European, American, Japanese and other leading economic countries and companies may create too many imbalances for emerging markets to digest. It's like watching a wave of locusts. This is potentially a positive impact long term for the American and European economies where the profits are being made but are emerging markets really benefiting? I haven't thought it all through but I suppose they are comparatively. In a circular kind of way, regardless of where the profits are made, it eventually does help the world. But, the flip side is that the wealth created is concentrated in a small percentage of the population. Maybe future investment will change that. Entrepreneurs looking for capital may find it in the form of Wall Street commodity profits.

I expect we are likely seeing the formation of a second commodities top as I wrote in April. Markets have been levitating with almost no movement for over a month. A potential double top is setting up in copper, oil, and some of the other industrial commodities. Since industrials are late stage performers, we very well could be putting a top into the overall asset markets sooner than I expected. We just have to see how dynamics unfold. I believe much of the smart money exited the commodities play last May and this attempted move back up has been significantly weaker from what I see.

I do not profess to be a copper, oil or uranium expert but I do consider myself to be an expert in identifying what isn't factual, trader mentality and Wall Street think. When reporters on TV and in the media become copper experts, the time has come to invalidate their stupidity. How about this: copper production is supposed to surge 500,000 tons past demand in the coming year? Sound like a reason to bid copper to nearly $4 when it has never been past $2 in the history of mankind and has spent most of its time substantially less than $1. Copper at $4 a pound is a little like charging someone for a pet rock. I heard a famous Wall Street type on TV talking about all of this demand for copper. One source of demand was electric motors requiring copper for hybrid cars. Well, I don't know what percentage of global copper consumption that is but that seems a stretch to me. Also, who said hybrid cars were a long term solution? Who said energy storage devices or batteries needed to be chemical as opposed to electrical or mechanical re zinc and lead? And, that somehow lead or zinc was going to be required as euphoric traders pound metals into the stratosphere? Wall Street traders don't know what scientists will discover. It's group think. They are looking in the rear view mirror.

A few weeks ago a well known pit trader who has become quite famous on American TV was talking about buying Cameco stock because of the demand for uranium. Excuse me but the time to buy Cameco was when no one wanted it. Uranium has gone from about $7 to $125 per pound. When pressed for where the demand was coming from, he said nonspecifically new nuclear plants. I guess there are quite a few going up in China but enough to drive global uranium prices up 1,500%? When told we have ten year licensing and building processes he said it was the existing American energy companies as power demands were soaring. Hmm. Now, that is pure hooey and he really looked stupid. I have an opinion about pit traders that they don't have to be very astute because they are playing off of the emotional dynamic in the pits rather than "with the program". Not all but many. That was surely a ridiculous statement yet that is what we are told by the supposed experts on financial TV.

Here's one. This morning I hear Mexican farmers are burning blue agave fields to grow corn for ethanol. Maybe. Well, blue agave is the plant used to make the world's finest tequila and it takes years to grow. Corn takes a few months. Now, I grew up on a farm and I bet a farmer in January, who was also planting corn for the ethanol craze, that soybeans would be higher on percentage terms than corn at the end of the year. The US is planting the largest corn crop in history. I'll bet anyone a life time supply of baloney that corn will not play a role in energy production in the long term.

The list goes on and on with other commodities and other ridiculousness. It reminds me of the Ben Graham statement oft quoted on here; "Wall Street learns nothing and forgets everything.". In this case, is it really Wall Street or main street?
posted by TimingLogic at 8:11 AM

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