Oil Price Volatility: Central Banks and Spooky Investors?

Global oil markets are coming to resemble something out of a D-grade science fiction movie, a monster with a life and will of its own bent on devouring everything in its path. But who created the monster, and who continues to feed the hungry beast?

...the advent of widespread Internet trading platforms radically increased the number of people with access to commodity markets, decreased the amount of time it took for an investment decision to impact the market and expanded the amount of money that could be applied to those markets. In particular, the creation of energy-indexed investment vehicles created additional demand for commodities by people who have no intention of ever taking delivery of the commodity.

...In any other market, the presence of a mass of new players would obviously have a distorting effect, but in the oil market, the inelastic nature of oil demand magnifies the investor presence. Since oil is so essential to modern life — needed for everything from transportation to making plastics, fertilizer or paint — industrial and retail demand for oil is actually fairly stable. The introduction of dynamic actors into a normally static system results in periodic and disproportionate price shifts.

...Over the past six years, the global money supply has roughly doubled. There are any number of reasons to expand money supply, but the most relevant ones of late have been to ensure that there is sufficient credit to stabilize the financial system. However, governments have few means of forcing such monies to go in any particular direction. And since the entire purpose of professional investors is to shuffle money to where it will earn them the highest return, some of the money from an expanded money supply often finds its way into commodity markets.

... In China, for example, such a huge and expanding money supply is keeping the country’s many profitless enterprises solvent, which keeps legions of unemployed from causing social instability or unrest. But it comes at the cost of inflation pressures, which could also cause unrest by consumers due to price increases. (The massive monetary expansion in China is symptomatic of a brewing crisis that STRATFOR expects to burst within the next few years.)

But for the commodity markets, including oil, the impact is clear: Prices will steadily rise — and on occasion dramatically fall — so long as the world’s monetary authorities keep expanding the money supply. _Forbes (STRATFOR)

Adapted from an earlier posting at Al Fin Energy

Unless one is a student of complexity, autopoiesis, and emergent phenomena, the seemingly disconnected movements of modern markets would be completely incomprehensible. But even under the best circumstances, the energy market monster is somewhat unpredictable in terms of timing the repeated rises and crashes.

Caution is recommended whether one is lulled into going long or scared into taking a short position. Oil is not gold, and should not be treated as a safe repository of value. Even gold and silver are subject to price swings, due to market psychology, geopolitical instability, and politically corrupt policies.

Try to be ready to take advantage of the inevitable erratic swings as they happen. For long term planning, make allowances for the likely volatility in energy and commodity prices -- as well likely erratic movement and possible collapse of selected currency values.

Brian Wang has more insight into some of the inadvertent effects of a weak dollar policy for the US