Economic Update August, 2008
COMMODITY BUBBLE?
SEA CHANGE?
By Jim Oelschlager
In the last month or so, we have seen virtually every commodity, be it grain, metals or oils, undergo a precipitous drop in price. It was only a few weeks ago when it seemed that commodity prices would go only in one direction. With respect to corn, people talked about the floods in Iowa, and they talked about the demand for ethanol. Yet, corn, after flirting with $8 a bushel, now sells close to $5 a bushel. With talk of droughts in Australia and record low storage, wheat flirted with a price of $13 a bushel, is now down to $8 a bushel. Oil topped out at $147 a barrel and is now down to $113 a barrel.
The following is a classic Wall Street tale: A prominent Street oil analyst has been saying consistently for a couple years, while the price was steadily ascending, that he expected the price of oil to drop sharply. About a month ago, however, with a very small amount of explanation, he revised his position and target for oil to reach $172 a barrel. Looks like he caught the top tick and could
be a great reverse barometer.
Of course, when crude was rising, the price of gasoline rose as well, though not at the same pace. Now that crude prices are dropping, my guess is that gasoline at the pump will be a little more sticky and not decline as quickly as crude declines. An interesting phenomena: the percentage of traffic deaths has
declined four times the percentage of miles driven has declined.
It wasn’t so long ago that people were resurrecting the Malthus Theory. Thomas Robert Malthus was a nineteenth-century English political economist and demographer. He theorized that population growth would increase faster than our ability to feed ourselves. This theory has been used to explain why the prices of commodities were rising so rapidly. We all know the story about demand from India and China; nevertheless, commodities have declined.
Declining oil prices could have an interesting impact on the elections this November. I hate to admit it, but James Carville was right, when Bill Clinton was running. Carville said, “It’s the economy, stupid!” He was right. It was the economy. It is almost always the economy in Presidential elections. For a short period of time, the Iraq situation was a primary concern in the minds of voters.
That has been eclipsed by concern over the economy. As oil prices increased, and the cost of gasoline increased, it acted like a tax increase on the consumer and took more money out of his pocket every week. Now, if it continues to reverse and decline, it will be like a tax cut and put a couple extra dollars, in a sense, in consumers’ pockets.
Consumer sentiment figures have been extremely low, lately; this is partly related, I believe, to the price of gasoline. If gasoline prices begin to drop rather sharply, I would suggest that the sentiment figures would start to improve, and the economy, in general would start to improve. The other benefit of sharply dropping commodity prices, again particularly oil, is it should have a very positive impact on the inflation numbers reported. We have seen some ugly headline inflation numbers recently; but, we may start to see some very positive, very pleasing inflation numbers in the future. Consequently, going into the November election, the consumer may start to feel a lot better; he may find that gasoline is significantly cheaper than it has been; and, after being in a funk over the economy, he may actually turn to an optimistic mode. This might change the dynamics of the election as they are perceived at this time. And, again -- “It is the economy, stupid!”
As I discussed in earlier Updates, the laws of supply and demand have not been repealed, and they seem to be taking hold here, particularly with respect to oil. There has been an increased attention to drilling and locating more oil and the consumption rate has dropped noticeably. Polls show now that people are more inclined to allow offshore drilling as opposed to several years ago when they fought it tooth and nail. Gasoline at $4.25 got their attention, and they didn’t care so much anymore about seeing rigs offshore. Oil spilled from rigs accounts for only 1.0% of the oil that washes up on the shore. The biggest contributor of oil that washes up on the shore is seepage through cracks in the ocean floor. The
next biggest culprit is accidents with tankers.
And, as I have said before, when everyone tries to exit a position at the same, time the door gets narrow. If the commodities continue to be weak, the commodity stocks should continue to be weak also, as they have been. In addition, the financial and consumer stocks seem to be doing a lot better after
doing so poorly. These groups may start to lead the parade, whereas the commodity stocks, which were leading the parade, may not do as well. In fact, since the commodities peaked, Oak’s portfolios have done very well on an absolute and relative basis.
I still want to bet that things aren’t different this time and that the laws of supply
and demand have not been repealed.
Best regards,
Jim
This manager commentary represents an assessment of the market environment at a specific point in time and is not intended to be a forecast of future events, or a guarantee of future results. This information should not be relied upon by the reader as research or investment advice.