Time for the oil bubble to burst?
Commodities markets seem to have become a den of gambling. With commodity derivatives being packaged into financial instruments, these are now traded like stocks and behave like stock market. And will most likely fall like the stock markets.
As per IMF commodity prices, especially those for foods and energy, have now reached levels where they risk becoming a destabilizing force in the global economy.
OPEC ministers are screaming all over the place that supplies are adequate and that the price rise are more speculation driven.
Energy analysts are now coming round to believe that the huge price rice is driven more by fund buying that by the particulars of the oil markets
The rise in price of crude oil to around $117 now from $ 50 a year back is not justified by purely demand-supply issues. The world production of oil as well as physical inventories are enough to meet the current consumption needs.
Here is what's happening
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Pure financial investors are investing in commodities, creating an artificial demand. They are not interested in buying bags of wheat or barrels of oil, but are keen to make a sell it off at a profit without taking delivery.
When inflation is on the way up, the price of commodities rise faster and become a still better avenue of investment. It just becomes a self feeding loop.
And what about the non speculative reasons.
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Here the key demand-supply related reasons:-
- Rising demand
- Use of foodstock as biofuels
- Increase in the consumption of meat
- Accidents and calamities
How much is real and how much speculative
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- As per Commodities Future Trading Commission, which regulates commodity futures in US speculators account for around 37 percent of outstanding contracts in U.S. crude oil.
- There is a research carried out by a researcher in Korea very recently where the researcher has tried to approximate the % contribution of key factors (speculation, demand-supply, dollar weakness and geopolitical reasons) in the commodity price rise. It seems for oil and wheat more than 40% of the price
rice has been contributed by speculative interests and another approx 40% by demand-supply reasons
- Oil ministers from nearly all the OPEC countries from Saudi (the biggest) to Qatar (smallest producer) are vociferous in their statements that there is no shortage of oil, that the inventories are piling up and the price rise has been driven by speculative interests. Is anybody listening to them ?
So what's likely to happen ?
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Here's some thoughts on the sequence of events. Difficult to forecast these things, so the estimates are 'more directional then exact.
Step 1
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Oil, food or the real estate bubble will burst, very close to each other. The prices of these commodities will correct significantly. Not sure which one will burst first. However the whole thing will start in the global markets and instantaneously spread to India too. That's very likely to be the first sign of the bottom of the global slowdown.
Step 2
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Across the globe, factor price correction will take place.
- significant drop in price of real estate
- interest rates will come down
- wages would be impacted
- corporate profits would be hit
- government fiscal deficits will rise.
Factor price corrections are already underway across the globe. Each bubble bust will provide a further downward push
At this point in time the atmosphere would be absolutely dreary and it would seem as if there is no hope of recovery . Exactly the feeling at the bottom of cycles in previous recessions too.
Step 3
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Inflation would be down. Consumption will slowly start picking up. Leading to a pick up in investment demand. And that's how the economic cycle will start turning upwards. |
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