Short a dollar

The seesaw markets

When everyone is on the same side of the trade, the time is right for a reversal. - John Mauldin

Markets seem to work a lot like a seesaw.  Fair prices lie in the middle and everyone trading stands on one side or the other, looking to buy, or looking to sell.  Once one side gets to heavy, people start moving back to the other side in order to balance things out.  Being that the market is inefficient it is constantly balancing from one side to the other as people try to figure out what the fairest price is.

As John Mauldin points out in his recent letter, commodities may be reaching that point where too many people are on the buy side of the balancing act.  With the theory that institutional investors (companies that manage pension funds, etc) have run away from the equity (general stock) markets and sought safety in commodities (particularly futures markets where you can buy commodities for delivery in the future).  This, due to seemingly lax regulatory practices compared to other markets, has allowed a great many institutional investors to take a once balanced commodities market and weigh it down on one side of the equation.

Now, it does not take a genius to realize that commodities, over time, will become more in-demand as various economies around the world grow.  However, that does not guarantee that today's price, that balancing point, is a good one in comparison to prices in the near and distant future.  Not having many other options for where to throw their money, institutional investors run to commodities markets for safety, weighing down the buy side of the seesaw. 

The thing to note about the see-saw is that no one actually knows where the real balancing point is or whether they are on the better end of the deal.  Being that people generally have a habit of suffering from group think and following the consensus of others, when there is movement on one side of the seesaw, others will see it and often rush to that side to join in the momentum. 

This changing in momentum is where we see small and large bubbles develop in markets as well as their subsequent crashes as people too easily rush to overweigh one side rapidly driving prices up or down.  Once there are far too many people on the same side of the equation, the seesaw is lopsided and those most in the know start run to the other side changing the momentum in the other direction all over again.

The regulation John Mauldin points out in his letter regarding traditional markets control how much people can buy of any given market, thus slowing how rapidly that seesaw rocks from one side to the other.  The problem, as is quickly being recognized by regulators, is that futures markets have a loophole that allow investors to get around those controls and this loophole may soon be plugged.  Once such controls are in place, the market will not rock so violently, however, if we presently are heavily weighted on the buy side of the equation few can predict how regulators will change things and whether it will cause a rapid or gradual overbalancing on the market.

The question that lingers with commodities markets is whether they are now so heavily weighted to the buy side that a reversal can take place in the opposite direction.  Certainly somewhere out there is a fair price for those commodities but that price remains largely unknown.  Everyone stands on one side or the other, looking to buy or looking to sell, running back and forth trying to figure out if the side they're on is the right one.  The markets simply seesaw from one side to the next.

Why are oil prices spiking?

Is peak oil finally upon us?  Should we panic?  Perhaps not, as thanks to an excellent article by Thoughts from the Frontline's John Mauldin we can get an idea of why oil prices have spiked as of late and it has less to do with peak oil and more to do with questionable political moves and the potential rise of a new bubble.

In his recent piece "Whither the Price of Oil?" John discusses how institutional investment houses (pension funds, etc) have been dumping tons of money into commodity based exchange traded funds (ETFs) as a means of taking their money out of the Sub Prime havocked markets and placing them into something that will hedge against rising inflation.  The problem however, is that ETFs largely rely on future's markets to cover new investments and as such have pushed futures prices up drastically. 

Now, because many ETFs hold oil futures, this has purportedly caused a run up of the price in oil alongside other commodities .

Adding to this are political concerns with regards to interesting movements made by Iran.  John  mentions how Iran has been leasing out all of the oil tankers they can get their hands on and are storing their oil in them.  Indeed, the Calgary Herald confirms this by suggesting that the number of tankers Iran has leased has gone from 10 on May 2nd to 20 by May 22nd.  It also confirms John's suggestion that Iran may be in a bad spot as the bulk of Iran's oil is of low quality and can only be processed by specialized refiners, namely in India, China and the US. 

As the Times Online notes, the problem may not be so much that the price of oil has risen as the price of futures, the paper guarantees of oil for a month or more from now have risen out of control.

"consider the situation today in oil markets: the Gulf, according to Mr Rothman, is crammed with supertankers chartered by oil-producing governments to hold the inventories of oil they are pumping but cannot sell. That physical oil is in excess supply at today's prices does not mean that producers are somehow cheating by storing their oil in tankers or keeping it in the ground. All it suggests is that there are few buyers for physical oil cargoes at today's prices, but there are plenty of buyers for pieces of paper linked to the price of oil next month and next year. This situation is exactly analogous to the bubble in credit markets a year ago, where nobody wanted to buy sub-prime mortgage bonds, but there was plenty of demand for “financial derivatives” that allowed investors to bet on the future value of these bonds. "

However, on the flip side of the coin, could the political motive exist for Iran to attempt to disrupt oil prices?  What is interesting to note is that back in December Iran stopped accepting U.S. dollars in exchange for oil, which we can recall was a move made by Iraq back in the year 2000 that wasn't very well received.  Could this be a partial cause for why Iranian oil is less in demand today?  Of further interest is that in February Iran inaugurated the Iranian Oil Bourse, an exchange dedicated to encouraging trade of Oil in non-US currencies.  Both moves being very anti-American suggesting an potential interest to stir the pot.

The large question that arises from this is that why would Iran lease so many oil freighters?  Is it simply for storage of oil they are no longer able to easily sell or is it something more politically malicious such as trying to cause a disruption?  Certainly by leasing so many tankers and leaving them sitting the availability of tankers to ship oil decreases, forcing leasing costs to rise and can also cause a restriction in supply.  One could certainly wonder, what is Iran's plan in this regard?

Questions that arise with regards to oil prices are where will they go next?  If Iran continues to hoard tankers will that cause oil prices on the futures markets to continue to rise and if so, to what extent will it continue and what action will the U.S. take as a result?  If Iran dumps all their oil on the markets and frees up the tankers, could we be in for a crash in the price of oil?  On top of that we have the issue of the money thrown into ETFs by institutions and what eventual impact this will have on things to come and then there is the question of what impact the suggestion that Asian countries may cut oil subsidies will have on overall demand.  While there are a great many unknowns, one thing seems pretty clear, peak oil isn't here...  yet.

New Home Sales?

An interesting note.  The markets are up after the announcement of a 3.3% month over month increase in new home sales while missing the detail that there is really a 42% decline in year over year new home sales when comparing against April 2007 numbers. 

 

From the associated press:

Stocks advance after surprise gain in home sales

NEW YORK -

Wall Street advanced Tuesday after the government reported the first gain in new home sales in six months, news that raised hopes for a recovery in the housing sector and that offset disappointing consumer confidence data.

The Commerce Department said sales of new homes rose 3.3 percent in April to a seasonally adjusted rate of 526,000 units. In March, sales had fallen 11 percent to their weakest pace since 1991.

 

From The Big Picture:

New Home Sales Fall 42%

Sales of new one-family houses in April 2008 were at a seasonally adjusted annual rate of 526,000, according to estimates released jointly today by the U.S. Census Bureau and the Department of Housing and Urban Development.

This is 3.3% (±11.7%)* above the revised March rate of 509,000, but is 42.0% (±8.1%) below the April 2007 estimate of 907,000.

 

Interesting charts:

courtesy of Barron's Econoday

 

Monthly new home sales (NSA - Not Seasonally Adjusted).

 

"Notice the Red columns for 2008. This is the lowest sales for April since the recession of '91. As the graph indicates, the spring selling season has never really started. "

courtesy of Calculated Risk

Import Genius

Import Genius is a really cool site worth noting for the future as it could offer implications for tracking trends in commodity shipments:

As described by the site:

"Within minutes of subscribing, you'll have access to lists of all of your competitor's suppliers and all of your supplier's customers in the United States."

Import Genius provides timely, detailed shipment data mined directly from the US Customs Automated Manifest System (AMS). Our user base is diverse: importers, exporters, entrepreneurs, freight forwarders, bankers, private investigators, foreign factories, and more.