MolloMarketReport

This is my first blog post - hope you all like it

Another bumpy day in oil

            After numerous reports over the weekend that the Saudis would be increasing output of oil naturally oil opens . . . up.  Black gold traded to a new record high within 11 cents of  $140 a barrel before reversing course to end down a mere 25 cents at $134.61.  Keep in mind that there will be options expiration this week both in futures and equities so that may add a bit more volatility to this already raucous commodity.  It is hard to say where oil will go from here.  My personal opinion is that we are in the midst of yet another bubble.  However we are in that phase of a bubble, where people point out we’re in a bubble and yet prices continue to rise. 

            The bulls’ strongest justification in my opinion is the falling dollar and monetary policy.  It generally takes about 9 months for Federal Reserve policy to reverberate throughout the economy.  If that is the case, then the effects of low interest rates on the falling dollar and hence rising commodity prices and inflation expectations that we feel today are the result of rate cuts from October of last year.  The October 31^st rate cut put the fed fund rate at 4.5% from its recent high of 5.25%.  Today it is at 2%.  Clearly we have a ways to go on the inflation side, despite recent attempts at “jawboning” by the Fed.  Considering that the last cut was on April 30^th any Fed induced inflation will not be fully felt until January of 2009; a nice welcoming present to either President Obama or McCain.

            So why do I feel there is a bubble?  First, what I believe is putting the greatest upward pressure (i.e. Over-low interest rates and its subsequent effect on the USD) will not exist forever.  The fed seems to have already realized that it can’t lower rates forever, and there is now speculation in the bond market that the Fed will start raising rates before the year is out.  This may be a bit optimistic (personally I’d like them to raise them now), but obviously at some point those inflation concerns will outweigh the effects of the dismal housing market.  Last month saw the peak of rate resets in ARM’s that have been causing so much havoc.  It will still take a few months for that peak to work its way through the system.  Next up would be a peak in the number of loans with missed / behind payments.  Naturally this is followed by a peak in foreclosures, a peak in empty homes on the market, etc.  But after the peak will the Fed feel it necessary to prop up the banking system with low interest rates?  Probably not.  This will be what finally takes the wind out of the oil bubble.

            Also, I find that many of the bullish arguments on oil are unsatisfactory in convincing me that oil should be at the current levels we are seeing.  Yes China and India, etc. are developing rapidly and hence will generate more demand for oil.  But in 2003 oil was $30 a barrel as opposed to today’s near $140.  Certainly China’s rapid economic growth is nowhere close to this kind of rise!  There are now reports starting to come out that people are actually cutting back on their driving; even here in the US where large automobiles are commonplace.  There is also a wide range of alternative fuels and engine types coming to the market.  It will take time, but one could assume that gains from technology will eventually overcome the demand created by a larger and more prosperous world population.

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