Commodities had a nice day Wednesday, with oil in particular spiking up. Although the trigger appeared to be the Fed rate cut, one has to wonder at the seemingly disproportionate price reaction, particularly given deteriorating fundamentals and hence falling demand.
One reason for the sudden enthusiasm for commodities is that, as in the frenzied days of last spring and early summer, hard assets can serve as an anti-dollar trade. And the dollar is looking pretty richly valued right now.
From the Financial Times:
Commodities prices rose sharply on Wednesday, with oil trading above $69 a barrel, as the dollar retreated after the Federal Reserve lowered US interest rates half a percentage point to 1 per cent.
The Reuters-Jefferies CRB index, a global benchmark for commodities, rose almost 6 per cent propelled by a surge in energy, metals and agricultural raw materials.
The price of several commodities, ranging from wheat to oil and from nickel to sugar, rose 10 per cent on the day. But traders warned that sentiment was weak and the gains could be shortlived amid worries about a global economic slowdown.
“Demand for physical commodities is tanking in many parts of the world, with US oil consumption contracting at the sharpest rate since 1980,” said Francisco Blanch, commodities strategist at Merrill Lynch in London.
In the oil market, Nymex December West Texas Intermediate jumped $4.77 to $67.50 a barrel after hitting a session high of $69.24, while ICE December Brent rose $5.18 to $65.47 a barrel after reaching a high of $67.12.
Dollar weakness and gains for equity markets outweighed the impact of the latest US weekly inventories data which painted a mixed picture. US crude stocks rose by 0.5m barrels, below the consensus forecast for a 1.4m barrel increase. But total US demand averaged 18.88m barrels a day over the past four weeks, down 7.8 per cent compared with the same period a year ago.
US petrol stocks fell 1.5m barrels, confounding the consensus forecast for an increase of 1.2m barrels. However, petrol demand remains weak, averaging 8.93m barrels a day over the past four weeks, down 3.4 per cent compared with the same period a year ago.
Nymex November RBOB unleaded gasoline rose 10.8 cents to $1.5628 a gallon.
US refinery utilisation rose 0.5 percentage points to 85.3 per cent, recovering towards the 88.8 per cent reached in late August just before the arrival of hurricane Gustav.
The market was also bolstered by further signs that the world will struggle to build enough oil production capacity over the next 20 years to compensate for steep declines in output in mature oil fields such as those in the North Sea, Mexico or Alaska…
James Steel of HSBC cautioned that next week’s US elections could weigh on gold prices if the new president was granted a “honeymoon” period by investors or if the dollar rallied after a new administration entered the White House.
Caroline Baum of Bloomberg throws cold water on the oil bull thesis:
Three months ago, the world was running out of oil…
Now there’s too much oil, prodding OPEC to cut production targets for the first time in two years…
World markets greeted the news of reduced oil supply by pushing prices down further. Crude oil fell $3.69 a barrel Friday to $64.15. Yesterday, oil dropped another 93 cents to $63.22, a 17-month low.
How quickly things change. Or do they?
All speculative bubbles have a kernel of truth behind them to justify their existence. This time around it was China and India. These emerging Asian giants were gobbling up all the commodities the world could produce to fuel their rapid industrialization.
It wasn’t that the story was untrue; it was old. Growing global demand probably was the reason for the gradual rise in oil prices from $20 a barrel to $40 earlier in the decade, and even to $60 by mid-2005.
It was the moon shot to $147 that took on a life, and a litany, of its own. Emerging nations didn’t start gobbling up crude, coal and copper all of a sudden in the middle of 2007.
Yet analysts on TV and in print told us with a straight face that the doubling in oil prices from July 2007 to July 2008 was a result of fundamental demand, not speculative buying or investors, including pension funds, “diversifying” into “alternative investments” in search of “uncorrelated returns.” (It sounds a lot better than admitting you got suckered into buying what was going up and are now stuck with a pile of stuff that no one wants.)
“It happens in every market,” says Michael Aronstein, president of Marketfield Asset Management in New York. “Once it goes up an enormous amount, creating unfathomable wealth for the fortunate participants, someone makes an ex-post case as to why we are only at a beginning and it’s not too late to get in.”
This advice is “generally formulated by someone who has a vested interest in selling the stuff,” he says…
The silliness that accompanies speculative bubbles isn’t to be outdone by what passes for economic analysis. It’s just over three months since commodities began their sharp, swift descent, and already the nonsense is starting: Lower oil prices are going to boost consumer demand.
Whoa! The price of oil (and other raw materials) is falling because of a cutback in demand, both actual and expected. Expressed as a graph, the demand curve for oil has shifted back, to the left. Consumers demand less energy (gasoline, heating oil) at any given price than they did before.
To say that lower prices will stimulate demand, a widely held misconception, confuses a movement along the demand curve (lower price, higher quantity) with a shift back in the curve (lower price, lower quantity).
Why this is such a hard concept to understand, I’m not sure. People imbue oil prices with all kinds of mystical powers. They see a falling price and treat it as a cause, not an effect.
That oil prices are falling in the face of OPEC’s announced production cuts — a reduction in supply would tend to raise the price, not lower it — suggests that demand is falling even faster than OPEC can reduce supply.
That won’t boost demand, but who knows? Maybe it will help recapitalize the banks!
Reader Michael also passed this thought along:
I almost forgot about nat gas…its bounced back with oil, but that’s got $4 written all over it…we can’t export the stuff yet we increased drilling to a level not seen since 83. These producers saw $20+nat gas overseas, and figured that’s where we were headed…but the demand picture is obviously different here…That’s why tboone and mcclendon were spending money on commercials, pleaing for people to create some sort of demand that would soak up this massive supply that will hit the mkt over the next few months.