Is Oil Cheap?   (May 29, 2013)


Gasoline is expensive at the pump, but by one measure oil is cheap and poised to go higher.

I recently posed this question to longtime contributor Harun I.: could global hot money flow into the crude oil market, driving the price up even if demand declines? The basic idea here is that if equities, bond and housing markets soften or roll over (please see What If Stocks, Bonds and Housing All Go Down Together? May 24, 2013), global hot money will seek speculative gains elsewhere.

In an era of rising geopolitical tensions (see Syria), what better place to notch a speculative gain than oil and gold?

Put another way: Is oil cheap? Harun offered a chart of the crude oil/gold ratio (in effect, crude oil priced in gold rather than nominal U.S. dollars) and the following insightful commentary:

Very good question. I suggest we not make the error of just considering nominal price. For example, below is a chart I marked up about a week ago, the Crude Oil/Gold ratio. I like relative-strength charts because they are a better indication of high and low prices and they tend to oscillate within a range. Here we see a history going back to the 1970s.

At the highs and lows consider what this meant to the economy at that time. What I find rather interesting is that, currently the chart is indicating crude oil is relatively inexpensive. However, one trip to the pump says something entirely different. In fact, prices at the pump are not far off their peak from when this ratio was at its height.

Now imagine what would happen to prices if this ratio returns to its high. Remember this is relative, there could be a demand collapse and this ratio could still go to its historic high. What would that look like in the economy? Well much like the Great Depression, plenty of stuff but no money to buy it. Commodities are real and the effects of hot money are felt almost immediately causing demand to collapse quickly because the real people that make up the economy don't eat paper. If hot money flows into crude oil driving pump prices to $8.00/gallon it would devastate the economy even further.

The Fed is trapped. There were no good answers in 2000, 2008, or now. But the room has gotten a lot smaller.

The reflationary bubble in equities has acted as a hedge but it has not increased purchasing power. No wealth has been created for the middle class. This is why the Fed cannot lift off the accelerator. Therein lies the problem. How does the Fed square the divergence of the equity markets and its monetary stance? How can it continue to claim that they are not the cause of inflation or bubbles?

Where will money flow? It may foment mini-bubbles in all things tangible, classic cars, precious metals, art, etc., as the wealthy scramble to get out of cash. But there will be no place to hide. This will get messy, but the revealing of really big lies always is.

The chart above is cause for grave concern. The fact that it is indicating that energy prices are cheap and have no place to go but up is sounding an alarm. It is my opinion that the average person is in no place (in terms of purchasing power) to absorb a return to the relative highs on this chart.

Thank you, Harun, for the chart and the commentary. You see what happens when oil becomes expensive: the economy sinks into recession.

The conventional wisdom is that oil should decline in nominal price as global demand weakens along with the global economy.

In the hot-money-seeks-a-new-home scenario outlined above, demand could decline on the margins but speculative inflows--demand for oil contracts by speculators--push prices higher, potentially a lot higher in a geopolitical crisis.

The central banks that are creating all the "free money" that is available to large speculators fulminate against oil speculators, as if all the free money is only supposed to go to "approved" speculations in equities and bonds.

Unfortunately for the central bankers, they only create the money, they don't control what the financiers who get the free money do with it.

Despite the endless MSM hype about U.S. energy independence and U.S. exporting energy abroad, the U.S. still imports over 3 billion barrels of crude oil every year: U.S. Imports of Crude Oil (U.S. Energy Information Administration).

Demand for imported crude oil fell 4.9% from 2011 to 2012, tracking lower gasoline consumption and miles driven. But that's still a figurative drop in the bucket of oil imports. Anyone who believes the U.S. is impervious to geopolitical oil shocks is on a Fantasyland ride with an abrupt stop in terribly inconvenient reality.



Things are falling apart--that is obvious. But why are they falling apart? The reasons are complex and global. Our economy and society have structural problems that cannot be solved by adding debt to debt. We are becoming poorer, not just from financial over-reach, but from fundamental forces that are not easy to identify or understand. We will cover the five core reasons why things are falling apart:

go to print edition 1. Debt and financialization
2. Crony capitalism and the elimination of accountability
3. Diminishing returns
4. Centralization
5. Technological, financial and demographic changes in our economy

Complex systems weakened by diminishing returns collapse under their own weight and are replaced by systems that are simpler, faster and affordable. If we cling to the old ways, our system will disintegrate. If we want sustainable prosperity rather than collapse, we must embrace a new model that is Decentralized, Adaptive, Transparent and Accountable (DATA).

We are not powerless. Not accepting responsibility and being powerless are two sides of the same coin: once we accept responsibility, we become powerful.

Kindle edition: $9.95       print edition: $24 on Amazon.com

To receive a 20% discount on the print edition: $19.20 (retail $24), follow the link, open a Createspace account and enter discount code SJRGPLAB. (This is the only way I can offer a discount.)



NOTE: gifts/contributions are acknowledged in the order received. Your name and email remain confidential and will not be given to any other individual, company or agency.

Thank you, Jane T. ($10/month), for your stupendously generous subscription to this site -- I am greatly honored by your support and readership.   Thank you, George K. ($50), for your gigantically generous contribution to this site -- I am greatly honored by your support and readership.


"This guy is THE leading visionary on reality. He routinely discusses things which no one else has talked about, yet, turn out to be quite relevant months later."
--Walt Howard, commenting about CHS on another blog.




Or send him coins, stamps or quatloos via mail--please request P.O. Box address.

Subscribers ($5/mo) and contributors of $50 or more this year will receive a weekly email of exclusive (though not necessarily coherent) musings and amusings.

At readers' request, there is also a $10/month option.

What subscribers are saying about the Musings (Musings samples here):

The "unsubscribe" link is for when you find the usual drivel here insufferable.

 
 
Your readership is greatly appreciated with or without a donation.

All content, HTML coding, format design, design elements and images copyright © 2013 Charles Hugh Smith, All rights reserved in all media, unless otherwise credited or noted.

I am honored if you link to this essay, or print a copy for your own use.

Terms of Service:
All content on this blog is provided by Trewe LLC for informational purposes only. The owner of this blog makes no representations as to the accuracy or completeness of any information on this site or found by following any link on this site. The owner will not be liable for any errors or omissions in this information nor for the availability of this information. The owner will not be liable for any losses, injuries, or damages from the display or use of this information. These terms and conditions of use are subject to change at anytime and without notice.


                                                                         
blog     My Books     Archives     Books/Films     home


 





Making your Amazon purchases
through this Search Box helps
support oftwominds.com
at no cost to you:


Add oftwominds.com
to your reader:


Free Page Rank Tool

Oftwominds.com #7 in CNBC's
top alternative financial sites

#25 in the top 100 finance blogs




Expat Your Wallet:
Open a legal & compliant
overseas bank account online

Q & A on how it works