05 October 2010

Oil is Riding Higher on Weakening Dollar and Phantom Demand

Oil has once again broken into the $80 + a barrel territory -- which is exactly where it needs to be in order to drive new oil exploration, discovery, and production. But how much higher can oil go before demand destruction begins hacking away at an already weakened global economy? Some pundits are predicting that oil will move to over $100 a barrel by January, others claim that oil will rapidly move to $150 a barrel or higher.

Most of these claims are based upon anticipated growth in global demand for oil. This demand is expected to be greatest in emerging countries such as China, India, the middle east, etc. But these pundits also expect to see a recovery in oil demand in North America, Europe, and other more developed nations. Is their expectation justified? If not, their oil predictions rest on very shaky ground.

Let's look at China:
All that spending is creating destabilizing gluts, particularly in production capacity. Mr. Roubini singles out the car industry as an example. This year, car sales jumped from eight to 12 million vehicles, a 50% increase. But production capacity went from 10 million to 20 million vehicles. "China now has 100 separate car makers," he says. "The U.S. has only three."..."You know, I go to China six or seven times a year, and you have brand-new airports three-quarters empty," he says. "Highways to nowhere all over the country." _NourielRoubini_inWSJ_via_BI
Not only are China's stimulus $billions going to build unused or under-used infrastructure, but the quality of the construction is quite poor. These buildings, bridges, roadways and railways will be in need of serious maintenance -- even replacement -- within the next decade or two, at the most.
Like Jim Chanos, Hugh Hendry is bearish on China.

But actually shorting China has never been a straightforward proposition. For one thing, due to the bubbly nature of the market, you can get your clock-cleaned really fast, even if you're correct in the medium term. So you have to make related bets. In the case of Chanos, he appears to be shorting commodity/infrastructure players that serve China.
Mr Hendry has constructed a portfolio that targets Japanese corporate credits as some of the instruments likely to be worst affected. The fund has taken short positions through credit default swaps, whose prices reflect the solvency position of issuers, against 20-30 single-name corporate bonds, the majority of which are Japanese.

“Being short China is difficult,” Mr Hendry said. “I could go to China and short equities, but that’s too volatile and I have unlimited loss. I could short commodities like copper, but that would be unlimited loss too, so I don’t like it. I could look for ways to be short Australia or Brazil, but there’s not enough optionality there. Japan is the most exposed economy industrially.”

What about the US' near-term recovery prospects? It looks as if house prices in the US still have further to drop. Goldman looks for US manufacturing to contract significantly over the next several months. And a number of economic indexes appear to indicate that the US is in the early stages of another drop into recession. And there are some indications that confidence in the recovery is beginning to droop.

Repeated $trillion dollar stimuluses can artificially paint a picture of recovery -- but not indefinitely. Eventually investors will refuse to lend to such a profligate spender -- particularly a big spender that suppresses its own private sector as harshly as Obama is doing.

Does Obama really need all those investors? Sure, Obama can always imitate Robert Mugabe of Zimbabwe, and operate the printing presses until he runs out of green ink. But turning the US into another Zimbabwe will have its drawbacks as well.

Perhaps the pundits who are predicting $150, $200, and $250 a barrel oil in the near future, have access to information that is denied everyone else. But anyone who did not learn a lesson from the disastrous demand destruction that accompanied the 2008 speculative runup to almost $150 a barrel is likely to repeat his mistakes -- and lose big -- yet one more time.

In the opinions of Al Fin financial analysts and investment bankers, the global economy (and the US economy) is in worse condition to deal with massive demand destruction from artificially inflated energy prices, than it was in 2008. Certainly the exponential rise in debt being experienced by most US states and the US federal government, will have dire consequences sooner or later. There is no telling exactly what will trigger those consequences.

Peak oil doomers always expect the price of oil to go up. "This time," they think, "this time is the big one. This time oil will go up, up, and up, and never come back down. This will prove that I was right all along." Of course, they have been saying this since the mid-1800s, and will likely be saying the same thing in the 2030s and beyond. But that is just stubborn human nature.

Smarter people need to look deeper beneath surface phenomenon and make their plans accordingly. If you know what you are doing, you might be able to ride along with the big speculative investors as they make money on oil going up . . . . and coming back down.

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“During times of universal deceit, telling the truth becomes a revolutionary act” _George Orwell

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