THE WAY IT REALLY HAPPENED

My history of posts on TOD US will demonstrate that I had repeatedly warned people against falling into the trap of believing that oil and other commodities were going nowhere but up in price. I say this not as a way of saying “I told you so” but as a way of reminding people to be very, VERY cautious about believing current projections.

The price of commodities shot up very quickly across the board, and then declined just as fast. Are we to believe that supply dropped that fast in EVERY AREA of commodities, and then recovered just as quickly? That does not seem likely. On the demand side, yes, demand has declined, but has it declined in EVERY AREA to the extent that price declines would indicate.

The fact that these price moves have been so fast, across the board and in both directions indicate that we are seeing a speculative bubble inflate and then pop, pure and simple, and price moves have little to do with supply and demand changes in the short term.

Logically we must ask, “What has caused such an acceleration in price changes over the last few years?” I think it is extremely informative that you mentioned first on your list of events “1999: Glass-Steagall Act is fully repealed”. Very perceptive observation to put this event right at the front of what would become the beginning of an accelerated increase in house prices, commodity prices and speculative investment. We must recall that another source of capital was the flood out of the already overextended tech sector.

With the repeal of Glass-Steagall and the flood of cash from the tech sector, we had a situation of huge amounts of money looking for a place to go. The banks could now jump in and play the speculative game just like the hedge funds and venture funds. Everybody, whether they knew it or not, was now playing in the casino and had money on the table, through hedge funds, banker’s investing in hedging, funds of funds, pensions, and homes, which would soon be subject to the same accelerated price swings that oil and other commodities were already subject to.

Needless to say, the new flood of free flowing money brought out the “adventurer” in bankers (now freed up by the repeal of Glass Steagall), hedge fund managers, market advisors and gurus and even mutual fund and pension fund managers. The “Lords of the Universe” now had the chance to show what they could really do, and investment vehicles tied to underlying commodities, interest rates, and collateralized debt obligations could become ever more complex, multi layered and “hedged” six ways from hell.

The main point of all this is that price swings which would have in past years happened much more slowly now happen with whiplash inducing speed. The flood of money, the complexity, the speed of the internet has accelerated the “Queuing Theory” past a point that allows for comprehension by most humans. If you add in the pure irresponsibility and outright fraud of managers and financial firms who purposely complicate things for the purpose of obfuscation, you have a recipe for disaster.

Oil, like real estate and houses and other commodities are simply the vehicles to which the financial manipulators tied their wagons. The real value of the commodity simply does not matter to the speculators and financial managers at banks and hedge funds. What matters is that people can be convinced to pour money into the investment firms on the belief that the price will change, hopefully to the investors advantage.

When the economy is growing and things are going up, the tool used to recruit investors is greed, i.e., “look at the return you can get on this, you don’t want to be left out”, and when they are going down the tool used to recruit is fear, as in “we have a hedge against losses that can protect you”.

Finally, there were too many people playing the same game. Everyone wanted double digit returns, and everybody was pouring money in, and there was plenty of money to go around at first, with the money that had fled the tech boom available, the massive returns made by the banks on the prior rises in real estate available, and the depositors money now available if it were need since the repeal of Glass-Steagall, and a new fast moving almost completely unregulated group of funds, the Hedge Fund, and then the “fund of funds”, which could pretty much do anything they wished without oversight, but, and this turned out to be very important, without insurance or government protection.

So when the U.S. invaded Iraq in 2003 oil prices were already rising after the price decline caused by the 9-11 terror attack, and the war further accelerated the price gains. Production was starting to flatten because in the 1990’s investment had slowed to a crawl because oil had been so cheap as to be beyond belief (we’re talking about prices below $20.00 per barrel) and the OPEC nations and others had simply stalled on investment in E&P. The rumbles of “peak oil” were just beginning to get into the media. This was a DREAM RECIPE for those who wanted to suck investors into investing in oil, gas and commodities. As you say, “The Rest Is History”, as money flooded into the commodities markets. When the housing market started to show signs of weakness, investors began to get scared, and the ones that were able to bailed out, selling houses. More sold, the market was getting full of houses, but now there were fewer buyers. A few foreclosures became a few more as some of the “house flippers” could not unload at a profit. Again the rest is history, and the money from the real estate boom needed somewhere to go. Commodities, yes, said the investment gurus, commodities were safe!

Brokerage firms who know almost nothing about oil production, consumption and pricing began to talk about $200 per barrel oil (the disgrace that was Goldman Sachs), and retired geologists were on every channel telling the public that the end was near, we would be lucky to get through the next summer (whichever of the last three or four summers they were referring to) without a catastrophe. And the money just kept pouring in, and the commodities skyrocketed.

And then, like all bubbles, the bubble popped. The financial gurus were in trouble and they knew it because frankly they had not gotten it right for their investors for too long. From the collapse of the S&L’s they had herded the investor from one short lived bubble to another, from Asian bonds to the tech bubble, to the real estate bubble, to the Euro bubble, to the commodities bubble. But the acceleration of the cycle of promotion, inflation, extreme high prices and then bursting of these bubbles had become too fast. Even the banks and hedge funds could not stay up, and the investors themselves were either become scared or had been so cleaned out by the gurus they couldn’t keep adding money. Again, the rest is history…

A story of a friend of mine who is in the business, by which I mean the financial sector: She had her clients in the stock market, well diversified, funds, ETF’s, mutual funds, and Index funds. She saw the bad news getting worse, so she persuaded them to move to something “safer”, a mix of REIT’s and, yep, you guessed it, commodities funds. She had become persuaded that oil and gas were only going to get more and more expensive. Do I have to tell you the results of what happened? Her investors are now down by more than 55%. Some of them are getting rather close to planned retirement, and are horrified. Even if the market returns to 10% annual returns, it will take years for these aging boomers to regain what has been lost, post taxes and fees it may take even longer than they may live, and how likely do you think it is that the market will soon deliver double digit returns?

Many in the Peak Oil community have embarrassed themselves badly by making wild claims about short term prices. The same thing has happened in the climate change community, where people have made wild predictions about short term weather changes. The Oil Drum has been unfortunate, in that it is a very open forum, and has posts from both of these movements, peak oil and climate change. This means that people come to TOD and see streams of posts which are based on the two most unreliable and unpredictable patterns in the world, weather patterns and market patterns. This is not TOD’s fault, and long time visitors to the site know that these projections/predictions must be taken with a HUGE grain of salt, but newcomers to the site do not grant this license and the whole cause of peak oil and climate change thus lose credibility in the larger public because a few posters have essentially decided they are prophets.

As for the future, I agree with you Luis, I would not dare to predict future prices. I will say this however: I would be happy to live the rest of my natural life with oil and gasoline prices as much as twice what they currently are., inflation adjusted, meaning I will accept gasoline prices of $4.00 to $5.00 per gallon U.S. (I have survived worse than $4.00 and I was poorer then) So obviously I could hedge by buying oil and gasoline futures at ANY PRICE CURRENTLY AVAILABLE and still be happy! I am not seeking massive returns, just a stable price for my lifestyle. I would be amazed if the very wealthy are not hedging their oil price futures just this way, but I could be wrong.

On the other hand, I have been astounded by how many wealthy people and families have pissed away their money with this Ponzi hedge fund scheme run by Bernie Madoff, and wonder how many more of these type of funds are out there. With apologies to De Niro, “Ah markets, I love the smell of default in the morning!”

Roger Conner Jr.