There is an old saying about markets: “The market can remain irrational longer than you have money.” And the fact is, there is very little rationality to the market whether it be stocks, bonds, commodities, or Forex. These past two years have seen great difficulty for the rational investor to make money by reason of sane investments, only the trend followers are able to pursue profit that appears to be more the making of lucky circumstances than anything else. Indeed, investing these days is more akin to betting against the house. And no wonder since the quantitative easing by the Federal Reserve and the issuance of an extreme amount of debt over the several past decades has made investment an exercise in statistical probabilities rather than an analysis of price to earnings, return on investment, and the other measures commonly used in the evaluation of stocks. The chase after ever higher yields caused by the additive borrowings made extremely attractive through exceptionally low interest rates means that values become grossly inflated and profits well over stated.
This excessive issuance of debt has driven the price of commodities up to excessively high levels. The role of the Chinese has been that of the drunken patron buying round after round not just for the house but for all the bars in the city. And when normal checks and balances, the rigors of GAAP are ignored and the governments become con artists ever willing to cook the books and call spades diamonds, then we have the ultimate problem in government, utter accountability and the eventual disbelief in its members. This is a systemic problem that will bring down all houses in not only our government but many others as well.
So what does the price of Oil have to do with all this? The market usually does not remember history at all, so it will always fall victim to the same patterns. America produces a great deal of oil for consumption here but it also sells some to other nations. Due to the nature of the distribution on refineries in the U.S. we can see that much of the Alaskan crude cannot be processed by the western refineries and so a fair amount is sold to the Japanese and the Chinese. There are no pipelines to transport the oil into the central states, the gulf coast, or the east coast. And the various refineries are built to hand specific grades of crude. One cannot change overnight from cracking Saudi sweet light to heavy sour crude, the refinery must be changed over and that takes both time and money. So transportation costs matter to some degree. The idea of building the pipeline called Keystone, from Canada to the gulf port refineries came because the only way to ship oil from the tar sands and oil shale production areas in central Canada is by rail, far costlier that building a pipeline. But on the one hand we have those environmentalists and others who believe pipelines are bad for the environment and on the other who oppose the rail traffic Either way they seem bent of stopping the importation of Canadian oil production into the U.S. although one may wonder why. This same oil poses a threat to West Texas Intermediate where the pipeline head in in Oklahoma. Why should good American oil be replaced by that foreign Canadian oil even if Canada is our 51st state?
But that is not all that is happening on the world’s oil supply stage. The discoveries of oil well off the shores or Brazil in very deep underwater locations has only added to the world supply. Such oil is only worth recovery if the price per barrel is high enough to cover costs plus profits. Then we have the rush by Norway and Russia to drill deep water wells in the arctic circle area off their respective coasts. These are expensive undertakings as well. The Nigerian problems, mostly political and involving both political factions and outright pirates has, to some degree, put under control and oil production resumed on a more regular basis. And let us not forget the Libya has gone through its political upheavals and oil and gas production has now resumed. Then all those “Stan” countries have been adding to the world’s reserves of oil and gas. The fact is, the production of shale oil and shale gas in the US and the rest of the world has been made possible by excessively cheap borrowing. The world’s debt situation has become a gigantic Ponzi scheme that makes all others look like children trying to sell candy to a baby. So what is the world situation on oil supply? There is currently an excess of supply and a reduction in usage. China is no longer using oil at a burn rate that makes the Americans look like Sunday drivers.
But that is not all that is happening. Commodity prices are falling greatly due to lack of demand. China is no longer building factories and cities that will never be used. Their demand for electrical production has been reduced through lack of industrial activity and gigantic construction projects. In the past ten years the play was in commodity speculation and boy did the speculators speculate, steal, even. Not that demand has collapsed the prices for raw commodities has collapsed with it. Australia is hurting and will suffer some severe economic reverses. Already mines are closing and layoffs appearing. Their housing bubble is bursting as it their job markets. And they are the only ones. Many developing countries are starting to see their trade with China decline. Right now China has become the middle man in the world markets. Where it once produced products using its own labor forces and factories, it has out sourced the unfinished parts to the various undeveloped countries where labor is still cheaper. But here in America we have seen a downturn in demand of goods coming from China. Our economy is roughly 65 to 70 percent consumer oriented. We may see it drop towards the 55 to 60 percent starting this year and continuing for the next decade. The fact is, the American consumer is out of money, too far in debt, and rapidly losing employment. Transfer payments will not make up the difference as that is trying to spend your way to wealth, although the MMT people disagree.
With most of the worlds derivatives, which include CDOs and all other manner of financial engineering (there’s a real oxymoron for you, more like creative accounting or fraud) denominated in U.S. Dollars, are we the lucky ones being the world’s reserve currency, that places a strain on the value of the Dollar. Simply put, as other countries or economic unions lose strength in their currencies either through poor economic and monetary policy decision or through deliberate devaluations and low pegging to the dollar, the dollar gains artificially in strength. The need to repay credit defaults with a very strong dollar is ruinous to most. s a rule, this demand for the dollar will be sufficient to create its own bubble before collapsing under its own weight. One might be tempted to sell the dollar short come mid year or year’s end. But then it is all relative since all if fiat currency and the only value any of it has is what any one will accept in payment for goods and services. The various governments will have no say in how the market will value their fiat currency. Well, something to think about as we wait for the collapse of hundreds of trillions of dollars of credit obligations, swaps, interest rate agreements, and the like. When that bubble bursts, the world goes back to zero.