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Baraka_Guru · 06-16-2008, 08:20 AM

The piece below suggests that oil markets shouldn't be compared to the housing market, nor should they be compared to the tech bubble. Some interesting points below that outline the contrast....

Quote:

Don't mistake crude's froth for a bubble

ERIC REGULY
ereguly@globeandmail.com

June 16, 2008

ROME -- Ten years ago, when the investing world was enthralled with Internet stocks and oil was cheap, a young analyst called Henry Blodget predicted Amazon.com shares, then trading at about $240 (U.S.), would rise to $400 during the next 12 months.

The shares jumped the next day like a cocaine-charged rabbit and Amazon reached his price target within three weeks.

They did so with scant evidence the online book seller presented genuine value.

Oil, now at $135 a barrel, is investors' obsession. The price has doubled since early last year.

On some days the price hikes have been phenomenal. During a 36-hour period over June 5 and June 6, oil rose by more than $16 to a record of almost $140.

Why did it go up so quickly?

How could it keep climbing with the United States barrelling toward recession?

Maybe it's time to blame the analysts again.

No, Henry Blodget has not been reincarnated as an oil analyst.

But his spirit might be living within powerful men such as Arjun Murti and Jeffrey Currie, both of Goldman Sachs, and both, thanks to their exceedingly bullish calls, the most famous brand names in the global energy-research business.

While the duo (who rarely give interviews) would cringe at the association, there is no doubt they and other analysts are taking some of the blame for what may or may not be an oil bubble.

In a June 10 letter published in the Financial Times, Michael Gordon, Fidelity International's head of institutional investment, did not specifically single out the Goldman boys for the wild price hikes of the previous week.

But he did say the "oil and commodity markets are in the hands of the investment banks and hedge funds right now."

Goldman, the investment bank, is probably the biggest player in the oil markets. It is a proprietary oil trader and runs a commodities index fund.

It is also the employer of Messrs. Murti and Currie. Mr. Murti, 39, lives in New York and is a managing director. Mr. Currie, 41, is in London and is Goldman's head of commodities research.

Both have been great believers for three or four years in oil's fortunes.

Mr. Murti gained prominence in 2004, when he coined the term "super spike" - a massive price surge. A year later he said oil would go to $105. It was about half that price at the time. You could hear the laughter throughout the oil markets, but his prediction would prove accurate. No one laughed when, in early May, he said prices could hit $200 during the next two years. By then he had become something of a guru.

His May prediction raised both spot prices and long-term prices.

A few days later Mr. Currie went bullish on long-term futures, too. He said "long-term oil prices will need to continue to rise to bring trend oil demand growth in line with trend supply growth."

Prices rose again.

Goldman was not alone in its forecasts. Merrill Lynch and Barclays Capital have also been bullish on long-term prices. Merrill has predicted a price of $150 or more. Ditto Morgan Stanley. Prices that high no longer seem outrageous, or even bold. It's as if the herd mentality has set in among oil analysts.

While the rapid price increases are unprecedented, it would be wrong to equate the Internet bubble and the analysts who exploited it to today's oil markets.

The tech analysts were wrong far more often than they were right. The Goldman analysts have been right far more often than they have been wrong.

Unlike the tech stocks, high oil prices can still be justified by fundamental values.

But how, then, do you explain the wild price hikes of June 5 and June 6?

It looks like the short sellers got caught in a massive trap.

When prices shot through $120, the speculators gambled that the sinking U.S. economy, the slowdown in some of the Organization for Economic Co-operation and Development countries and the gradual removal of transportation-fuel subsidies in some Asian countries would conspire to force oil prices down.

What they didn't count on was falling U.S. oil inventories and a falling U.S. dollar (as the dollar declines, the oil price goes up). Then an Israeli cabinet minister said an attack on Iran was "unavoidable."

As the short-sellers realized their bet was wrong, they covered and the price climbed so fast that it set a single-day record.

But what about the institutional investors?

True, they have been plowing billions into the commodity markets. But Barclays Capital reported earlier this month that the net inflow into index assets during the first quarter was just $2-billion, hardly enough to explain the oil price rise in that period.

It looks like the Goldman analysts, and others, have latched on to a fundamental truth: The world needs more oil than it can produce.

Falling consumption in the United States and the other OECD countries is being more than offset by soaring demand in Asia.

British-based BP PLC's annual statistical review, published this week, said total oil supply fell last year by 130,000 barrels a day as some once-prolific fields in Norway, Mexico and elsewhere ran out of puff.

Oil inventories in the United States are well below their five-year averages.

Messrs. Murti and Currie are not bubble makers. It doesn't even look like there is a bubble.

Futures matter, sure, but the overall impact is likely to be minimal at most. I've thought this for a while now. I will maintain my position: Oil prices are up due to a lack of increased capacity (via new sources) and diminishing output (think Mexico), in conjunction with an overall global creeping demand. This will only get worse.

But it is political as well. This is a complex issue, which is why no one has any clear solutions. We tend to look for the silver-bullet solution (or magic pill, if you prefer) but this is oil. It isn't that simple. Throwing food into the mix only adds to the laundry list of pressures. It's hitting a critical mass. The question is, what are we going to see down the road that will make it worse?