Tuesday, June 17, 2008

Oil-buying craze tops excess of dot-coms

And the speculator bubble is due to burst, analysts say

[The silver lining in high oil prices is that those damn SUVs are becoming increasingly undesirable to people and they're trying to trade them in for Hondas. I hear from Honda dealers that they're offering SUV trade-ins of $2k and the sellers can't believe it - DL]


The rally that recently drove oil to a record $139.12 a barrel has surpassed the gains in Internet stocks that preceded the dot-com crash in 2000.

Crude has risen 697 percent since trading at $17.45 a barrel on the New York Mercantile Exchange in November 2001 and reached 28 record highs this year. The last time a similar pattern was seen in equities was eight years ago, when Internet-related stocks sent the Nasdaq Composite Index up 640 percent to its highest level ever, according to data compiled by Bloomberg and Bespoke Investment Group LLC.

The Nasdaq has tumbled 78 percent from its March 2000 peak, erasing about $6 trillion of market value, as investors concluded that prices weren't supported by profits at companies such as Broadcom Corp. and Amazon.com Inc.

But billionaire investor George Soros and Stephen Schork, president of Schork Group Inc., say oil is ready to tumble because prices aren't justified by supply and demand.

"There's nothing different between this mania, the dot-com mania, the real estate mania, the Dow Jones mania of the 1920s, the South Sea bubble and the Dutch tulip-bulb mania," said Schork, whose Villanova, Pa.-based firm advises the Organization of Petroleum Exporting Countries, Wall Street firms and oil companies on the outlook for energy prices. "History repeats itself over and over and over again."

Oil has climbed on growing demand from China and India, whose economies have expanded the past seven years at an average annual pace of 10.2 percent and 7.3 percent, respectively. Supply disruptions in Nigeria and Iraq and declining production in Russia also have boosted prices. Investors have added about $250 billion to commodity index trading strategies since 2003, according to Mike Masters, president and founder of Masters Capital Management, a St. Croix-based hedge fund.

Money is flowing into oil as the global economy slows. The worst U.S. housing slump since the 1930s and more than $390 billion of write-downs and credit losses at banks will slow global growth to 2.7 percent this year from 3.7 percent in 2007, according to the World Bank.

The U.S. economy's expansion may slow to 1.3 percent this year from 2.2 percent in 2007, dragging down oil demand by 240,000 barrels a day, according to economists surveyed by Bloomberg and Energy Department data. In China, the second-biggest fuel consumer after the U.S., economic growth may fall to 10.1 percent from 11.9 percent, the Bloomberg survey shows.

"I don't know if you can classify it as a bubble or not," said Masters. "But there is no question that investor demand is having an effect on price. Very little of it has to do with physical supply and demand of crude oil."

Gains in oil are the result of a "bubble" caused by speculation from index funds and a tight balance between supply and demand, Soros said in testimony before the Senate Committee on Commerce, Science and Transportation on June 3. "The bubble is superimposed on an upward trend in oil prices that has a strong foundation in reality," he said.

Commodity index traders account for about 40 percent of the open interest, or outstanding contracts, in the 12 agricultural commodities for which the Commodity Futures Trading Commission reports data, according to Chicago-based Bianco Research LLC.

Crude futures more than doubled in the past year and surged $10.75 a barrel on June 6, the biggest rise on record and the largest in percentage terms since June 1996. Robert Aliber, a professor of economics emeritus at the University of Chicago Graduate School of Business, says the risk of a "correction" has increased because prices climbed so fast.

"You've got speculation in a lot of commodities and that seems to be driving up the price," Aliber, co-author of "Manias, Panics, and Crashes: A History of Financial Crises," said in an interview from Hanover, N.H.. "Movements are dominated by momentum players who predict price changes from Wednesday to Friday on the basis of the price change from Monday to Wednesday."

Burton Malkiel, a Princeton University economics professor and author of "A Random Walk Down Wall Street," said the rise in oil may be justified because supplies are limited and demand in developing economies is increasing. That distinguishes oil from the market for technology stocks in the 1990s, where supply "could be expanded infinitely" and new stock issues helped push down prices, he said.

"The picture is fundamentally different than the Internet picture," Malkiel said in an interview from Princeton, N.J. "I'm not saying we're running out of oil, but we're clearly supply-constrained. Five and 10 years from now, the price is going to be higher than $134."

"You can look at the chart and say oil's taking on the characteristics of a bubble," said James Bianco, the president of Bianco Research. Still, "it may have a long way to go before it eventually peaks," he said.

No comments: