Commodities tumble across the board, oil below 120.

[SirNitram]

Link

Aug. 4 (Bloomberg) -- Plunging prices for cocoa, natural gas and sugar sent the Reuters/Jefferies CRB Index of 19 commodities to it biggest one-day decline since March.

The CRB index fell 3.4 percent to 401.98, which marks the largest slide since March 19. The gauge dropped to the lowest level since May 2 today, as did the UBS-Bloomberg Constant Maturity Commodity Index.

The CRB slid 10 percent in July, the most in any month since March 1980, when the U.S. economy was in a recession. A worsening global growth outlook and prospects for increased supply sent raw materials such as crude oil, soybeans and gasoline tumbling from records in the past month.

``Speculation had been driving these markets and they were due for a correction as so many prices had gotten overdone,'' said Peter Sorrentino, who helps manage $16.7 billion at Huntington Asset Advisors in Cincinnati. ``There are moderating growth expectations that are going to hurt industrial commodities. Going forward, you have to be very selective.''

Cocoa was today's biggest loser, dropping as much as 9.5 percent to a six-month low of $2,712 a metric ton on ICE Futures U.S., the former New York Board of Trade. Natural gas fell as much as 8.3 percent to $8.616 per million British thermal units on the New York Mercantile Exchange, and sugar was down as much as 6.5 percent to 13.21 cents a pound on ICE Futures.

Economy Slows

The U.S. economy shrank at the end of the 2007 and grew less than forecast in this year's second quarter, signaling that the country is in worse shape than investors had anticipated, the Commerce Department said last week. Manufacturing in China, the world's fastest-growing major economy, contracted in July for the first time since a survey began in 2005.

Slowing global growth will mean ``there won't be a tide to lift prices,'' Sorrentino said. ``Before, you could look at commodities and buy across the board. Now, you have to be much more nimble.''

The CRB posted its best first half in 35 years, gaining 29 percent in the first six months of 2008 as investors stocked up on raw materials as an alternative to stocks and bonds and as a hedge against the weakening dollar.

Commodities are ``at the beginning of a long-term bear market,'' after rallying the past seven years, Michael Aronstein, chief investment strategist at Oscar Gruss & Son Inc. in New York, said last week.

Aronstein correctly said in June that prices for raw materials would start to decline. The CRB index has lost 13 percent since June 30.

Oil, Copper, Gold

Crude oil lost as much as 4.5 percent to $119.50 a barrel on the Nymex, the first drop below $120 since May, amid speculation that Tropical Storm Eduoard won't cause disruption to most offshore oil facilities as it approaches the coast of Texas.

``Crude is leading everything down,'' said Hector Galvan, a senior market strategist for RJO Futures in Chicago. ``People have that fear of not wanting to be the last one on the boat -- it's `abandon ship' for the short-term.''

Copper tumbled as much as 4.3 percent to $3.426 a pound on the Comex division of the Nymex, the lowest price since Feb. 8. Inventories monitored by the London Metal Exchange reached the highest level since February. Aluminum, nickel and other industrial metals also fell. Platinum capped the biggest two-day decline in 22 years.

Falling prices may hurt profit for producers including BHP Billiton Ltd., the world's biggest diversified mining company, and Anglo Platinum Ltd., the world's largest producer of the metal. The Bloomberg World Mining Index of 139 companies tumbled 13 percent in July. The gauge lost as much as 4 percent today.

Grain Slump

Corn and soybeans both fell more than 5 percent, dropping as much as the daily limit allowed on the Chicago Board of Trade, as favorable weather may boost the crops.

The grains may continue to fall as demand from China, India and other emerging economies slows, said Daryll Ray, the director of the Agricultural Policy Analysis Center at the University of Tennessee in Knoxville.

``There has been much more optimism about China and India and the export market than facts support,'' Ray said. Prices may fall through 2009, he said.

Gold, wheat, coffee and orange juice also declined. Hogs were the only commodity monitored by the CRB to gain today.

Big drops across the board, but the eye-catcher is oil going below 120. Don't think it'll stay that low, but, for now, it's a touch below most estimates as to where it should be.

[Ender]

Of course, TX has a Hurricane watch going on now, so expect this to change rapidly.

[J]

I suspect, though have no proof a hedge fund went kablooie today and set off a cascade of margin calls throughout the commodities sector, or maybe all the investors got together and did a co-ordinated sell-off, I lean towards the former. I was trading oil earlier today when all of a sudden there was a huge volume spike lasting around 5 minutes where tens of thousands of contracts were liquidated all at once. A quick look around the rest of the commodities revealed a similar volume spike at around the same time, it started with natural gas, took out the rest of energy and then it killed corn,grains & agriculture before taking out metals. Everything was going fine until around 11:20 this morning and then all of a sudden, wham, one commodity after another went down on massive volume.

[SirNitram]

Given the recent drop in the price of oil as the most on record, it doesn't surprise me there's shitloads of liquification of contracts. No one wants to hold a peice of paper bought at 144/brl that could drop as low as 110/brl.

[bobalot]

The US is heading into recession. Fuel consumption in the largest oil consumer is expected to drop. I think the prices will eventually rise as the supply fundamentals haven't changed a great deal (total production has pretty much stagnated).

India and China will slowly start picking up the slack.

[Fingolfin_Noldor]

I suspect, though have no proof a hedge fund went kablooie today and set off a cascade of margin calls throughout the commodities sector, or maybe all the investors got together and did a co-ordinated sell-off, I lean towards the former. I was trading oil earlier today when all of a sudden there was a huge volume spike lasting around 5 minutes where tens of thousands of contracts were liquidated all at once. A quick look around the rest of the commodities revealed a similar volume spike at around the same time, it started with natural gas, took out the rest of energy and then it killed corn,grains & agriculture before taking out metals. Everything was going fine until around 11:20 this morning and then all of a sudden, wham, one commodity after another went down on massive volume.

Weren't there a number of hedge funds that were marked close to collapse? I remember Bear Stearns or some other company having insolvent Hedge Funds.

[K. A. Pital]

Interesting. I'm currently a bit in a travel, so I can't watch the most interesting index, the grain prices.

[Master of Ossus]

Weren't there a number of hedge funds that were marked close to collapse? I remember Bear Stearns or some other company having insolvent Hedge Funds.

A substantial fraction of all hedge funds go under every year (probably somewhere around 25%, but maybe as high as 50-60%). In fact, it's hard to even estimate the returns on hedge funds because there's so much survivor bias.

The US is heading into recession. Fuel consumption in the largest oil consumer is expected to drop. I think the prices will eventually rise as the supply fundamentals haven't changed a great deal (total production has pretty much stagnated).

India and China will slowly start picking up the slack.

But demand side changes are what caused the increase in the first place (that and improving foreign currency performance against the dollar).

[Surlethe]

The US is heading into recession. Fuel consumption in the largest oil consumer is expected to drop. I think the prices will eventually rise as the supply fundamentals haven't changed a great deal (total production has pretty much stagnated).

India and China will slowly start picking up the slack.

But demand side changes are what caused the increase in the first place (that and improving foreign currency performance against the dollar).

Demand will continue to grow, won't it? IIRC from the WSJ a few weeks ago, Asian demand growth has started to decelerate, but it's still at something like 6-8%/year. The US is definitely decreasing fuel consumption in tandem with its economic woes, but is that enough to seriously offset growth in the rest of the world and keep prices down?

It should also be noted that lower oil prices will spur greater consumption, which will drive prices back up again.

[Sarevok]

So in a nutshell the price drop is due to increase in oil production and reduction of demand ?

[Sikon]

Supply:

The red line is added approximately where there is the division between historical data and prediction: mid-2008 since
the graph is a recent July 2008 graph:



Demand:

Global oil demand is estimated as 86.6 mbd first quarter 2008, 86.2 mbd second quarter, and 86.6 mbd third quarter.

It is predicted to decline in the U.S. by 0.6 mbd in 2008 and 0.4 mbd in 2009, while at the same time increasing in
Asia by 0.7 mbd in 2008 and 0.6 mbd in 2009.

IEA

--------------

Apparently after oil reached figures like $145/barrel, many investors starting doubting they could count on further rise and started withdrawing. Its rapid rise was getting rather high considering current supply versus demand, so it's not surprising it wasn't sustained indefinitely.

Whether going up or down, such has a way of snowballing for a while, as more and more people look at the recent trends and don't want to lose money by being left behind.

That's much like stocks. Typically, if a stock is rising fast, more people buy it, seeing a profit opportunity, raising prices still more ... for a time, until it gets unsustainable. Likewise, if a stock decreases, often the decrease accelerates for some time before eventually leveling out.

[Surlethe]

In other words, (as we knew) the volatility is the result of speculation, which is obscuring whatever market fundamentals are at work. I'm starting to more and more favor banning speculation outright, and regulating that only those who use commodities may purchase futures contracts. That, it seems, would eliminate the speculation-induced volatility and still permit the futures markets to function as price stabilizers.

[Sea Skimmer]

What may have happened is the Saudis and other major producers simply said ‘we’ll deliver’ on all these contacts signed at inflated price. Faced with the prospect of actually having to pay full price for oil known to be inflated in value, people started jumping ship. I know this has happened in the oil markets during speculation booms before; pumping more oil isn’t the only way oil producers can and do manipulate prices. In this case dropping oil prices is in oil producers interest, because lowering demand for oil will hurt them more then being paid slightly less per barrel, and a major world economic shift against oil would be especially bad.

[J]

It's possible that key OPEC producers shorted and delivered into the contracts leading into options & contract expirations week, and that probably tripped the automated trading programs used by brokerages which then continued the sell-off for the next while. It looked pretty orderly to me until yesterday when almost every commodity was slammed down on massive volume in a span of around 5 minutes, quite a few veteran traders I've talked to were left shaking their heads, it was nuts.

[Master of Ossus]

Apparently after oil reached figures like $145/barrel, many investors starting doubting they could count on further rise and started withdrawing. Its rapid rise was getting rather high considering current supply versus demand, so it's not surprising it wasn't sustained indefinitely.

Whether going up or down, such has a way of snowballing for a while, as more and more people look at the recent trends and don't want to lose money by being left behind.

Uh... where does risk play into your considerations? Oil is just another commodity that is traded the same way. Supply and demand are both more volatile, though, with oil than with many other commodities that Americans are used to being affected by, and its price changes are vastly more publicized.

That's much like stocks. Typically, if a stock is rising fast, more people buy it, seeing a profit opportunity, raising prices still more ... for a time, until it gets unsustainable. Likewise, if a stock decreases, often the decrease accelerates for some time before eventually leveling out.

That's nonsense: stocks are almost entirely traded by people who actually know what they're doing (certainly the marginal traders are people who have figured it out), and adjust in essentially real-time to the market and to new information about the companies that are coming out.

In other words, (as we knew) the volatility is the result of speculation, which is obscuring whatever market fundamentals are at work. I'm starting to more and more favor banning speculation outright, and regulating that only those who use commodities may purchase futures contracts. That, it seems, would eliminate the speculation-induced volatility and still permit the futures markets to function as price stabilizers.

What, precisely, is your definition of "speculation," and how did it create volatility that obscured market fundamentals?

[aerius]

That's much like stocks. Typically, if a stock is rising fast, more people buy it, seeing a profit opportunity, raising prices still more ... for a time, until it gets unsustainable. Likewise, if a stock decreases, often the decrease accelerates for some time before eventually leveling out.

That's nonsense: stocks are almost entirely traded by people who actually know what they're doing (certainly the marginal traders are people who have figured it out), and adjust in essentially real-time to the market and to new information about the companies that are coming out.

No, they're not, most traders can't find their own ass with both hands. I'll have to track down the source again, but when only 5% of traders can break even in a bear market, that's pretty damn incompetant. A lot of stocks aren't even traded by people anymore, the trading is done by automatic technical analysis programs at brokerage houses which look at price trends & volume and then punch in the bids & asks, at most the human operator might set a stop-out price and that's it.

Sikon is correct, most trading these days is merely trend chasing. Just to give an example, Wachovia is well on the way to going the way of IndyMac, they lost record amounts of money and their losses are accelerating. But they annouce they're going to raise capital via massive share dilution and the convertible's at something like 8%, there's no way in hell they can afford to pay it when the shareholders cash it in. But the stock goes up 5% or so on the announcement day and everyone piles in and pushes it up nearly 30% over the next few days on huge volume. Which is complete bullshit since Wachovia has just diluted their shares and fucked over their own finances even more than they're already fucked, the capital they're raising doesn't even cover their latest quarterly loss. Then the profit taking began and everyone dumped out as fast as they bought in.

[Sikon]

Apparently after oil reached figures like $145/barrel, many investors starting doubting they could count on further rise and started withdrawing. Its rapid rise was getting rather high considering current supply versus demand, so it's not surprising it wasn't sustained indefinitely.

Whether going up or down, such has a way of snowballing for a while, as more and more people look at the recent trends and don't want to lose money by being left behind.

Uh... where does risk play into your considerations?

Perceptions of the future such as perceived risk certainly affect oil prices. News of a coming hurricane can affect oil prices before it hits. Or, if news were to occur convincing many that a war with Iran was imminent, prices would go far up. Etc.

But is that really contradictory to my observation of trends in the previous post, though?

If one wants to list more effects, there's also, for example, changes in the U.S. dollar versus the Euro.

(While I didn't attempt to have a long comprehensive post, that's partially because both of the preceding have been repeatedly mentioned before anyway, such as in some of my prior posts in other threads).

Oil is just another commodity that is traded the same way. Supply and demand are both more volatile, though, with oil than with many other commodities that Americans are used to being affected by, and its price changes are vastly more publicized.

More volatile? How volatile quantitatively?

It's of note that, at least in the manner the IEA defines demand, such is calculated as 86.6 mbd first quarter 2008, 86.2 mbd second quarter, and 86.6 mbd third quarter ... not constant but somewhat close to constant in such a timeframe, due to increasing by a fraction of a million mpd in some regions of the world yet decreasing in others. (Prior IEA report link: here).

In the short-term, that's rather limited volatility for demand as the IEA defines it, with world demand going down by 0.5% between the first and second quarters, then going up by what happens to be the same amount.

Relatively, world demand is 1.00 units, then 0.995 units, then 1.00 units again.

Total world supply has been 87.0 mbd first quarter 2008, with that dropping slightly to 86.4 mpd second quarter 2008, then thought to be slightly increasing again according to the IEA. The second quarter production was 0.993 as much as the first quarter.

Again, that's also rather limited volatility for world supply in the short-term. (In the longer-term, of course it would change more). Fluctuation on the local level is greater than for overall world supply since so often decreases or increases in one area are mostly neutralized by the opposite in another region.

Yet oil prices went from being $80 early in the first quarter of this year to reach $147 at their peak in the second quarter, then now come down to under $120 so far. Even with oil being a rather inelastic good and even if the somewhat lesser degree to which prices changed in Euros was considered, that is quite notable compared to how total world oil supply and IEA-calculated demand was closer to constant over that timeframe.

That's much like stocks. Typically, if a stock is rising fast, more people buy it, seeing a profit opportunity, raising prices still more ... for a time, until it gets unsustainable. Likewise, if a stock decreases, often the decrease accelerates for some time before eventually leveling out.

That's nonsense: stocks are almost entirely traded by people who actually know what they're doing (certainly the marginal traders are people who have figured it out), and adjust in essentially real-time to the market and to new information about the companies that are coming out.

If someone knows what they are doing, the logical thing can often be to buy a stock if it's rising fast, provided that rise will probably last at least a little while longer, if then one can sell it afterwards at the higher price. Even in the case of oil rather than stocks, someone who invested in oil when they noticed it started climbing above $80 a barrel near the start of this year and then got out three weeks ago when they noticed it started going below $130 a barrel would have made awesome financial returns.

(Actually, even a lot of professionals don't seem to have managed actions like such a tens-of-percent net financial gain in a few months, so definitely some are better than others at making money; there can't be too much uniformity in how well nearly everyone knows what they are doing).

I'm still not seeing exactly what about my statement makes you describe it as nonsense. Would "typically, if a stock is rising fast, more people buy it, seeing a profit opportunity, raising prices still more" be more valid if it said "if a stock is rising fast, typically no more people see a profit opportunity and no more people buy it?" Surely you aren't saying that, so what exactly is your point?

No doubt some of the most successful professional traders may manage sophisticated study of a company and its probable future than some other investors like ordinary individuals putting some of their money into stocks. Some will have insider information or greatly research and analyze a company, but there is going to be a certain percentage of total investors with mostly similar sources of information to the general public. After all, some stockholders literally are individuals in the general public, for example.

Those who buy and sell stocks consider news about the company but at least many of them also look at trends too (like the individuals I know personally). Websites showing trends in historical prices of stocks over past months are extremely popular.

There definitely appears to be a significant amount of trend-chasing, and Aerius gives a good example.

[Master of Ossus]

No, they're not, most traders can't find their own ass with both hands.

Doesn't matter--only the marginal trader is relevant. And that's most traders, but it doesn't account for volume.

I'll have to track down the source again, but when only 5% of traders can break even in a bear market, that's pretty damn incompetant.

Obviously because they're not trying to break even during a bear market--they're trying to make a profit overall. My stocks don't break even during bear markets, because they're designed to provide a return over a long period of time (although they lose a lot less, now, than they did when I was younger).

A lot of stocks aren't even traded by people anymore, the trading is done by automatic technical analysis programs at brokerage houses which look at price trends & volume and then punch in the bids & asks, at most the human operator might set a stop-out price and that's it.

Sikon is correct, most trading these days is merely trend chasing. Just to give an example, Wachovia is well on the way to going the way of IndyMac, they lost record amounts of money and their losses are accelerating. But they annouce they're going to raise capital via massive share dilution and the convertible's at something like 8%, there's no way in hell they can afford to pay it when the shareholders cash it in. But the stock goes up 5% or so on the announcement day and everyone piles in and pushes it up nearly 30% over the next few days on huge volume. Which is complete bullshit since Wachovia has just diluted their shares and fucked over their own finances even more than they're already fucked, the capital they're raising doesn't even cover their latest quarterly loss. Then the profit taking began and everyone dumped out as fast as they bought in.

Or you don't know the whole story and there was more information that was beign analyzed that you don't have access to or simply didn't look up. There's a lot to analyzing cash flows.

[Master of Ossus]

More volatile? How volatile quantitatively?

It's of note that, at least in the manner the IEA defines demand, such is calculated as 86.6 mbd first quarter 2008, 86.2 mbd second quarter, and 86.6 mbd third quarter ... not constant but somewhat close to constant in such a timeframe, due to increasing by a fraction of a million mpd in some regions of the world yet decreasing in others. (Prior IEA report link: here).

In the short-term, that's rather limited volatility for demand as the IEA defines it, with world demand going down by 0.5% between the first and second quarters, then going up by what happens to be the same amount.

It's limited volatility in supply and demand, but the elasticity of gasoline and many other important oil products (plastics, jet fuel) is extremely small--we're talking in the range of .004, in the short-run, so even slight supply or demand shocks can have a tremendous increase in the price of oil. If the price of oil is (for instance) $120, and there's a drop of 1% in supply for a month, and assuming that the elasticity of oil is identical to the elasticity of gasoline and assuming linearity, then the price of oil will rise to over $160 during that month. A one percent drop in monthly supply is a plausible result of many, many world events.

Relatively, world demand is 1.00 units, then 0.995 units, then 1.00 units again.

Which results in a massive fucking decrease in the price of oil, assuming linearity.

[snip]Again, that's also rather limited volatility for world supply in the short-term. (In the longer-term, of course it would change more). Fluctuation on the local level is greater than for overall world supply since so often decreases or increases in one area are mostly neutralized by the opposite in another region.

We're not talking about supply. We're talking about volatility in prices.

Yet oil prices went from being $80 early in the first quarter of this year to reach $147 at their peak in the second quarter, then now come down to under $120 so far. Even with oil being a rather inelastic good and even if the somewhat lesser degree to which prices changed in Euros was considered, that is quite notable compared to how total world oil supply and IEA-calculated demand was closer to constant over that timeframe.

Oil being an inelastic good entirely explains the fluctuations you just cited. Indeed, the amazing thing is that oil prices have been so stable for so long (although, that's more a function of groups like OPEC that have carefully monitored and matched changes in demand for decades).

If someone knows what they are doing, the logical thing can often be to buy a stock if it's rising fast, provided that rise will probably last at least a little while longer, if then one can sell it afterwards at the higher price. Even in the case of oil rather than stocks, someone who invested in oil when they noticed it started climbing above $80 a barrel near the start of this year and then got out three weeks ago when they noticed it started going below $130 a barrel would have made awesome financial returns.

Except they would have no guarantee that the price of oil would continue to increase. It's real easy to say, in retrospect, that people should have bought or sold at a particular point in time, but the market price represents the consensus as to the correct price for a stock or commodity at a given time. This is easy to prove to yourself: suppose that it wasn't true. Suppose that a small population could correctly anticipate future changes in the price of a commodity. What would happen? Well, they would all immediately purchase or sell that commodity... until it reached the price that they knew it was supposed to reach. In other words, they would trade it until it reached the market price.

This is also why use of insider information is so dangerous for markets, and is often considered the only way to consistently beat the market on a given stock or commodity.

(Actually, even a lot of professionals don't seem to have managed actions like such a tens-of-percent net financial gain in a few months, so definitely some are better than others at making money; there can't be too much uniformity in how well nearly everyone knows what they are doing).

Most of those investors don't buy heavily in a particular stock or commodity, but rather select a package of stocks and commodities that are designed around an investment strategy. Conservative strategies are designed so that when some stocks are losing money, other stocks will be making it. Aggressive strategies assume that there will be some future event that the market has not correctly anticipated, and select stocks or commodities that are designed to reflect that event.

There's a reason why there are so few people who consistently beat the market: it's extraordinarily hard to do. I also challenge you to find a single one of them who follows stock "trends" in the way you describe. Indeed, people like Warren Buffet behave in precisely the opposite manner to the one that you predict should be the correct strategy (e.g., when a stock that they hold drops in price relative to the market they respond by buying more of it, since its cash flow is comparatively more affordable).

I'm still not seeing exactly what about my statement makes you describe it as nonsense. Would "typically, if a stock is rising fast, more people buy it, seeing a profit opportunity, raising prices still more" be more valid if it said "if a stock is rising fast, typically no more people see a profit opportunity and no more people buy it?" Surely you aren't saying that, so what exactly is your point?

That is my point. Regardless of whether a stock price is rising or falling, there are an equal number of buyers and sellers (e.g., just as many people think that the price is going to go down as think that it is going to go up at any given moment). Your statement reveals a profound misunderstanding of how prices are set in the market.

No doubt some of the most successful professional traders may manage sophisticated study of a company and its probable future than some other investors like ordinary individuals putting some of their money into stocks. Some will have insider information or greatly research and analyze a company, but there is going to be a certain percentage of total investors with mostly similar sources of information to the general public. After all, some stockholders literally are individuals in the general public, for example.

It's very, very difficult for financial analysts to tell their clients, "This stock has been going up for a while. I'm going to invest in it for that reason, and if you put your money in my hands then I'll do the same thing for you, too." Moreover, any changes in the overall price made by those investors will immediately (or almost immediately) be counteracted by people who actually know what they're doing--the marginal investor.

Those who buy and sell stocks consider news about the company but at least many of them also look at trends too (like the individuals I know personally). Websites showing trends in historical prices of stocks over past months are extremely popular.

I'm guessing that you only know small-time investors who really don't know what they're doing, but historical trends are not tracked by legitimate traders except for very specific purposes, and I've never heard of a serious investment company tracking prices in the manner that you describe.

There definitely appears to be a significant amount of trend-chasing, and Aerius gives a good example.

I know that some investors place stock (pun intended) in such methods, but the market does not, and market prices are not likely to be significantly influenced by these investors, if only because their influence over market prices will be corrected by people who know what they are doing. The market price is set at the margin, and the marginal investor almost tautologically understands what's going on.

[Sikon]

Yet oil prices went from being $80 early in the first quarter of this year to reach $147 at their peak in the second quarter, then now come down to under $120 so far. Even with oil being a rather inelastic good and even if the somewhat lesser degree to which prices changed in Euros was considered, that is quite notable compared to how total world oil supply and IEA-calculated demand was closer to constant over that timeframe.

Oil being an inelastic good entirely explains the fluctuations you just cited.

Entirely? Just that as a sole factor?

Here's a graph:



(Data is from here, plus here, here, etc).

Let's see:

By the standards of the small changes in supply and demand that have occurred over the past few months, supply goes up a lot between September and October of 2007, but, instead of decrease in price, oil price goes up greatly from about $75 to $90/barrel over that timeframe. And so on...

It's of note that, at least in the manner the IEA defines demand, such is calculated as 86.6 mbd first quarter 2008, 86.2 mbd second quarter, and 86.6 mbd third quarter [...]

Relatively, world demand is 1.00 units, then 0.995 units, then 1.00 units again.

Which results in a massive fucking decrease in the price of oil, assuming linearity.

Compared to actual historical data, your kind of modeling assumptions don't work very well here:

You talk about a "massive fucking decrease" in the price of oil between the first and second quarters of 2008 when instead prices vastly *increased* over that timeframe from $80 to $140/barrel.

If oil had near-infinite inelasticity instead of the actual figure, if supply was instead constant, and if there were no other factors ... then, in a simplified ideal theoretical market, there would have been a massive overall decrease in the price of oil between the first and second quarters of this year due to world demand going from 1.00 to 0.995 units.

But that's not what really happened, not when the actual situation has more involved.

Let's further check your kind of assumptions by doing another example with historical data, this time considering both the changes in supply and demand at once.

According to IEA figures illustrated here, in the fourth quarter of 2007, total world production was 86.4 mbd, while total world demand was 87.1 mbd. Then in the first quarter of 2008, total world production increased to reach 87.0 mbd, while meanwhile total world demand decreased to 86.6 mbd.

World production increased by 0.6 mbd while IEA-estimated demand meanwhile decreased between 4Q07 and 1Q08 by 0.5 mbd.

So did prices have a massive decrease as you apparently would have expected if you looked at the data?

No! They meanwhile *increased* from ~ $75/barrel to up to $110/barrel over that timeframe. There was a huge increase even if such prices are measured in Euros.

Of course such changes in supply and demand have an effect on price, but there's more going on than your assumptions alone consider.

Oil is a relatively inelastic good. However, the recent enormous changes in oil price over the past few months are literally three orders of magnitude greater than the supply/demand changes. Even more importantly, their rise up and down does not track well enough with those changes for the latter to be the sole factor.

A single order of magnitude difference would be one thing, but three orders of magnitude is something else. What if it had been a factor of a million difference instead of just a few hundred to 1000+ times? At some point, it should lead to a suspicion there is more going on than the market directly tracking supply/demand changes alone.

It's limited volatility in supply and demand, but the elasticity of gasoline and many other important oil products (plastics, jet fuel) is extremely small--we're talking in the range of .004, in the short-run

Do you realize what enormous consequences there would be for the world if the price elasticity really was so astronomically low as just ~ 0.004? For example, a small portion of just U.S. Department of Energy funding could be applied in a manner drastically changing oil prices for the whole world.

Then adding 0.002 as much as current production or paying for that much reduction in usage would cause ~ 50% change in world prices, saving the U.S. hundreds of billions of dollars a year and giving payback quite literally orders of magnitude more than the expense of doing that.

However, confidence in you looking properly at real-world data is not inspired by how your stated figure for elasticity of demand differs by one to two orders of magnitude from what other sources than a webboard post suggest.

For example:

It turns out that there are a lot of studies which calculate what the price elasticity of demand is. There seems to be at least 100. Fortunately there are two good meta-analyses which examine the work of many different studies on the matter.

One such study is Explaining the variation in elasticity estimates of gasoline demand in the United States: A meta-analysis by Molly Espey, published in Energy Journal. Espey examined 101 different studies and found that in the short-run (defined as 1 year or less), the average price-elasticity of demand for gasoline is -0.26.

That is, a 10% hike in the price of gasoline lowers quantity demanded by 2.6%. In the long-run (defined as longer than 1 year), the price elasticity of demand is -0.58; a 10% hike in gasoline causes quantity demanded to decline by 5.8% in the long run.

One example

In a period of a single quarter of a year instead of just the under-1-year definition of the short term, it's plausible that price elasticity is a little less than the ~ 0.26 figure.

But your 0.004 figure differs by a factor of 65 from that, a difference of about *two orders of magnitude.*

An article back from May 30th of this year:

Is George Soros right about an oil price bubble that will burst?

With oil prices hovering around $130/barrel this week, the obvious question is how high can the price go. There are plenty of factors that affect the price of oil including possibly waning supplies, increasing demand and, of course, speculation. George Soros has made billions in his career by being able to judge where markets are going to go and then react accordingly. As the old investment disclaimer always, past performance is no guarantee of future results. Nonetheless, when Soros speaks people would be well advised to listen.

In an interview with The Daily Telegraph, Soros seems to think that speculation is a much bigger part of the price run up than most other experts. If speculative buying is indeed playing a bigger part than supply/demand curves, then at some point the price will inevitably come down. And if this scenario does play out the price will come down hard.

From here

Was that billionaire investor right back in May?



... a 20% price increase in a matter of several weeks followed by a sudden drop of almost 20% over 2 weeks.

[Sikon]

In the context of the previous post, it's worth highlighting part of this thread's opening post article as a good illustration:

``Speculation had been driving these markets and they were due for a correction as so many prices had gotten overdone,'' said Peter Sorrentino, who helps manage $16.7 billion at Huntington Asset Advisors in Cincinnati. ``There are moderating growth expectations that are going to hurt industrial commodities. Going forward, you have to be very selective.'' [...]

``Before, you could look at commodities and buy across the board. Now, you have to be much more nimble.''

The CRB posted its best first half in 35 years, gaining 29 percent in the first six months of 2008 as investors stocked up on raw materials as an alternative to stocks and bonds and as a hedge against the weakening dollar. [...]

Copper tumbled as much as 4.3 percent to $3.426 a pound on the Comex division of the Nymex, the lowest price since Feb. 8. Inventories monitored by the London Metal Exchange reached the highest level since February. Aluminum, nickel and other industrial metals also fell. Platinum capped the biggest two-day decline in 22 years.

It's not just that supply versus demand in each of a bunch of items from cocoa to oil changed independently that drastically in the past few days.

It's not just that physical platinum production during those 2 days increased by X amount with Y elasticity of demand to cause Z price change, while physical natural gas production recently increased by A amount with B elasticity of demand to cause C price change.

This is somewhat a matter of the effects of investor perceptions, and the article itself talks about speculation.

``Crude is leading everything down,'' said Hector Galvan, a senior market strategist for RJO Futures in Chicago. ``People have that fear of not wanting to be the last one on the boat -- it's `abandon ship' for the short-term.''

That sounds like a significant amount of trend-following to me.

[Zac Naloen]

All I need to know is,


Is this a good or bad thing in the long term?

A one word answer will do but elaboration is always welcome.

[cosmicalstorm]

All I need to know is,


Is this a good or bad thing in the long term?

A one word answer will do but elaboration is always welcome.

I would personally not be suprised if a whole lot of people who recently have been looking into alternative fuel sources will suddenly stop that and think that everything is OK.

[Glocksman]

Meh..
Even if gas hits $2/gallon I still plan on buying a small motorcycle or 'maxi-scooter' next year.
50-70 MPG beats the shit out of the 19/city I get out of my 1992 3.3L Oldsmobile.

[aerius]

All I need to know is,

Is this a good or bad thing in the long term?

Good and bad. Good since I get to make more money by shorting on the way down then buying back in at the bottom and riding it back up. Bad since people will now go "crisis over!!!" and go back to buying Hummers.