Thursday, June 19, 2008

The Fool On The Hill

Twenty four hour news formats have most people believing the reason for higher gas prices is due to rising global demands of crude oil and American’s dependence of imported oil – especially from OPEC nations.

Demand for fuel in China is the best smoke-screen. It’s easy to visualize masses of people on bicycles now driving Cadillac’s with 2 car garages – thus Americans can conclude “it’s out of our control” so just pay the price.

For those just awaking ….there is a small square bock of real estate in Manhattan called Wall Street, the buildings there (and in similar markets throughout the globe especailly London); control the world’s financial conditions good, bad or indifferent.

The Street forecasts
The Street invests
The Street controls

Pay $5.00 for a gallon of gas … The Street wins.

I’ll explain.

Let’s say a group of investors concocted a strategy where it buys future stockpiles of medical equipment to price levels where the average American or Health Care provider couldn’t pay the cost any longer. One day the price of an x-ray is $100 the next day $800 and the next day $1500 – Americans would be outraged!

Over the past 25 years the price of oil and the price of a gallon of gas were paired, both rising, but matched in even parallels. Since 2002 the price of oil disconnected itself from the price of gas like a run-a-way train, the spread is alarming, if it were a cardiogram the patient would have already died.

Index Speculators claimed their territory post September 11, fueled by Institutional Investors, Mutual funds and University endowments… Index Speculators have become as critical to world oil markets as China, both place equal amounts of pressures to continue the rise in oil prices. The key difference is Index Speculators buy “oil indexes” and China buys the “actual commodity”.

As more Oil Index Speculators…”speculate”… the sheer mass of long positions assure higher prices.. the unsupervised frenzy feeds itself.

Could the oil bubble burst? Possibly.. however traditional supply and demand models are paralyzed – eight fold price increases in any commodity over an 8 year period doesn’t increase demand it reduces it (yes even with China consuming more oil). Thus increasing oil production won’t work because we already have an oil surplus.

The only remedy is to eliminate Index Speculation on all commodities. Without Index Speculation investor risk is tied into an obligation to cover short positions by buying the actual commodity, thus placing the focus on real supply and demand swings. Till then Index Speculators remain the core reason Oil and Food prices continue to increase.

The fool on the hill sits alone but has the ability to see the big picture.