| |  | | Andrew Gordon | Looking for a reason behind the sky-high oil prices? Last week I gave you one, “of course, it’s the speculators,” I wrote. And most of you agreed with me. But this isn’t a popularity contest. The majority is wrong all the time. It could be wrong this time, as well. And that would put Mr. Gary B. squarely in the right. He begins passionately enough: “I think your story on oil speculation is pure crap...” Resolute. To the point. And seemingly very heartfelt. It’s a shame he looses his way rather quickly in a fit of rationality: “I do agree that a ton of long only passive money has come into the market and esp. in the back end… this money has had a great impact and has taken potential sellers out of the mkt…” That’s what I’m talking about, Gary. You do understand after all ... um, don’t you? Too late. Gary regains his contrary equilibrium and quickly stages a frontal attack: “But the price of oil is at, let’s say $140/bbl because that’s where there are willing buyers and sellers…” He’s got me. I can’t dispute the truth of that anymore than I could dispute the truth of people buying houses and condos at ridiculously high prices a couple of years ago. Perhaps they thought that high demand for those houses and condos justified the price. Perhaps they thought that high prices in the housing market were here to stay. In a bubble – rather conveniently – there is always talk of shortages. And there is always the idea floating around that things have fundamentally changed… things like pricing and valuation (the dotcom bubble comes to mind) ... and that the very calculus of supply and demand no longer follows the standard bell curve. That’s not you, Gary, is it? Oh my, it is: “it’s at $140.00/bbl as demand is surpassing supply… it’s at $140.00/bbl because the old cheap days are over … the only people bitching are the one’s that missed it… yes we might go back to approx $100.00/bbl but the cheap days are over.” Over for good? That’s an awful long time, but that’s clearly what Gary means. If he would just put the time spectrum in the realm of the finite, I’d probably agree with him. Supply does indeed look like it’ll be tight for the next 5-10 years. After that, my crystal ball gets a little cloudy. I know, however, that nuclear will be kicking in within the next ten years (China, India, and Russia lead the list of countries with ambitious nuclear energy plans). I’m also pretty sure by that time some new major offshore fields will be giving up their oil. And I have to believe that electric cars and hybrids will be plying the roads in large numbers. Add it all up and supply has a real chance to catch up to demand. I’m not making any guarantees. There are plenty of “peak oil” believers who like Gary think that crude supply will never catch up to demand. But technology will have its day on both ends of the supply and demand equation. I’m not ready to say “the cheap days are over.” Sorry about that, Gary.
The best question of the day goes to Peter R. He “totally agrees” with my assessment of oil. But then he drops this perfectly logical question on me: “What makes you feel that the bubble will burst? Sure demand is / will fall but that didn't push the price to these lofty levels in the first place so how will lessening demand have any great impact?” Gravity? What goes up has to come down? Prices don’t rise forever? Phew! Now that I got those maxims out of my system, let me try to answer Peter’s great question. I’ve had many discussions about bubbles. A couple have been with my brother. He’s not an economist. And he doesn’t follow the market. But he’s a smart dude and he claims that bubbles are a “rear-view mirror” event. What he means is that you can’t be sure a bubble is a bubble until it bursts. By definition, then, all bubbles burst. But it does nothing to help you identify a bubble as it is occurring.
Bubbles are rogue. They defy market fundamentals. In a bubble, prices float higher on sheer momentum and expectations. Peter has a point. As long as the speculators believe their own propaganda about prices going up, they’ll go up. Fundamentals be damned. But let’s not forget that a cheap dollar is feeding this monster. Sure, it’s an inflation hedge. But as the value of the dollar goes down, it takes more dollars to buy a barrel of crude. In euros, a barrel of oil costs the equivalent of $90. In U.S. dollars, it costs $145. A strengthening dollar can go a long way in bursting this bubble. What else? How about something that will put a huge dent in their smug expectations of higher prices? I believe a global economic slowdown would do the trick. It would have to be more than just the U.S. and Europe. And it would have to be more than a ratcheting down of growth by one percentage point. If it becomes obvious that Asia is hunkering down and oil demand is seriously pulling back, the speculators will take notice (they’re not dummies, you know) and start looking for a top. The drop could be as steep as the climb. And leading the charge down? You guessed it: the speculators. There are a lot of other great comments that I simply don’t have the space to include. I will include Gene E.’s because he caught me in an embarrassing faux pas. Gene, I have to hand it to you, you’re the only one who noticed. I need to be more careful in the future. You can get into trouble confusing the clergy with journalists. I’ll let Gene have the last word: “By-the-by, journalistic "pencil-pushers' are part of the 'Fourth Estate', rather than the third - this was established during the 18th century in France, when the First Estate was the monarchy, the Second was the nobility, and the Third Estate was the Clergy. I doubt you'd want current members of the journalistic corps to be included with the clergy, especially those from Fox.” Thanks all for the great feedback. Please continue to give me your best shots. I really enjoy reading your comments. Invest well, Andrew Gordon P.S. To let me know what you thought of today's article, send an e-mail to: feedback@investorsdailyedge.com. | 
