Wednesday, July 23, 2008

The Economic Situation (7) - Unknown Oil

The big fly in the ointment is the price of oil. It has doubled in the last few years. Opinions differ as to what will happen next. Some say that the fundamentals mean that the price will drop to $US20 a barrel. Others say that it will increase to $400.

The truth is that no one knows. It is impossible to look at the fundamentals of any good and decide what the price should be. The Soviet Union proved this to be true. They tried to look at the fundamentals and decide what the price of good should be, but they always got it wrong. They set the price of bread to low, so there were always shortages and people had to queue. Other prices were set too high, producing a glut of goods that nobody wanted. The truth is that no person or organisation has sufficient knowledge to determine what the price of any good should be. The benefit of markets is that prices go up and down to ensure that supply matches demand.

I smile when people say that based on fundamentals, they know what the price of oil should be. These fundamentalists do not understand markets.

There are several factors that make the price of oil particularly hard to forecast. Some are positive and others are negative. I will look at them tomorrow.

1 comment:

Gene Redlin said...

Your Comment:
I smile when people say that based on fundamentals, they know what the price of oil should be. These fundamentalists do not understand markets.

We have a name for people who rely PURELY on fundamentals - BROKE.

But, to be a technical analyst without a keen eye on the fundamentals can destroy you just as quickly. A person doing technical analysis must do more than rely on chart patterns and moving averages. I believe in Kondratiev as much as the next guy but without a careful evaluation of the open interest and volume to determine momentum it has every potential of being a trap.

Much of the hype about oil has been people looking at what they believe to be market sentiment without looking at the underpinnings. How much is there, what is the demand, what is the supply flow, is the demand sustainable and elastic and is the supply elastic, how elastic?

Is the prices effect on the elasticity of the market more dramatic on supply or on demand.

When I have used the fundamentals to make the pronouncements I have made I am convinced that people are greedy and frightened at the same time on both sides. Greed and fear drive this thing. Greed to make as much money as you can on the supply side at a these prices will drive a supply bubble, fear you might miss out on these prices. I was a farmer. I know what it's like to plant Oats and pray that you can hit the market. We would hedge and then hope. and fear.

So, yes I agree central planning doesn't work. But don't be so quick to discount the effect a careful examination of the fundamentals will give a person.

Oil will see $100 and maybe 80 if the dollar gets legs (that's a human controlled factor, something over which I have no analysis whatsoever).

This will take a lot of pressure off the economy. I just with the Government would get out of the business of trying to prop things up that should be allowed to fail and quit regulation.

That is the real failure of Communism. There would have been lots of bread without the regulation in the bad old days.