Sunday, August 19, 2007

Inflationary cycle

I just ran a quick study of the number of players in both the gold and oil futures markets with some interesting results.

First off let me lay a bit of groundwork. In the 70's we were in a similar situation as today. We were fighting a very expensive war and we had entered a commodity bull cycle. Now wars are almost always paid for by governments printing money or inflation if you will. This time around is no exception. The value of the dollar has gone from 120 to 80. Seems pretty obvious the United States government is opting for the standard payment method. After a 20 year bear market in commodities the bull cycle has started again because supply and demand are out of balance. When that happens prices rise until balance is restored. The problem with commodities is that it takes time to bring more supply on line. While this time passes prices continue to rise. The most important commodity and the one the whole world is totally dependant on is oil. There is no substitute. When a government opts for the printing presses in order to pay for a war it exacerbates commodity inflation because these excess dollars eventually find there way into hard assets that are already in heavy demand. More than anything else when the price of oil spikes economies take a hit. Classic 70's markets follow. Spikes in oil price followed by economies in turmoil and repeating bear markets. So unless the powers that be are stupid and I don't think they are this time around they need to keep the price of energy reasonably in check or face the same outcome as the 70's.

Now back to my study today. I've noticed that the total number of participants in the gold futures have remained steady for the last 5 years. Not so for the oil markets. They have been increasing steadily since 04. Have we all of a sudden had a bunch of oil companies and refiners spring up that need to hedge production forward? As far as I know we haven't built a refinery in 30 years and we haven't really seen a flood of oil companies coming into the market. There seems to be mostly the same ones that have been around for years. Actually quite a few have merged. So where is all this extra interest coming from? I'm just guessing here and I may be totally off base but when we saw Goldman rejigger their gasoline weightings last year to bring down the price of gasoline I got the feeling that governments are going to try to control the energy markets this time around and hope for a different outcome than in the 70's. Let's hope it works because if any of you happen to remember the 70's and early 80's weren't the best of times