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« The Market Chose Death! Or Did It? | Main | The Fed Will Raise Rates »

Tuesday, June 10, 2008

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skierwaver

I don't quite see the point in Mauldin's logic. The futures market is a zero sum game. In order for anyone to take a long position there must be someone who agrees to take the opposite side of the trade. No matter how much money is willing to enter on the long side, they cannot do so unless someone agrees to sell to them. The algebraic sum of the total open interest must be zero. It is not possible to drive up the long open interest without increasing the shorts. Unless I misread him, Mauldin seems to say that everyone and their buddy are crowding over to the long side. That's not possible.

When one examines the COT charts it appears that Commercials - whoever they are - are in fact currently closer to the long side of their range of the last year or so, and large investors are relatively bearish (it looks like they may have been selling the recent advance). Small specs are relatively neutral.

slow to cancel

Guys, I think EN had a good point the other day about broken support. And, geez, why don't we finally mention the huge gap in the NASDAQ 100 from April. More downside seems very likely to me.

TObject

Yelnick, also from Mauldin's letter - your "Surge" money ;-))

"..
Finally: George Friedman told me that the Saudis are taking in something like $10 billion a week! The entire gulf is awash in dollars. He thinks it may have nowhere else to go but to the stock markets of the world. We'll see. Unintended consequences."

Tom CZ

re skierwaver>

the point is how strong is the validity of current CFTC data. If you look to money index being flown from non oil companies into this market compared to few years ago - it is rising in parabolic manner - so there is! inflow of money and this market is being squeezed. If you look to OPEC forecast made to 2030 they see demand rising from current say 80 mb/d to around 130 mb/d by 2030 so rising demand around 3-4%
a year and supply beeing increased the same pace till 2020 where starting to consolidate but beeing complemented by biofuels to fill real demand. So the real market sees no jumps. If you look to correlation of oil to the buck then thats very close (now little weaker but still) but with beta much higher than one. The story is weak dollar - until then it goes weaker the denomination of crude in $ rises in parabolic manner due to hot money playing this game and thats also why Berni who in fact loves his weak dollar starting to speak for him.

yelnick

TObject - exactly. The Global Scramble for Yield has to go somewhere. Where to go after the Commodities Bubble bursts? Then the Surge ... it cannot happen until the last bubble bursts.

yelnick

Skiwaver - he sees the funds that play long as constantly increasing and rolling forward their positions, and the investment banks they 'swap' with taking short positions to offset. This is a travesty that the CFTC allows, and it was exposed in testimony a month or so ago, and nothing was done. This hedging by banks against long positions can grow unchecked a long ways. If the funds were to liquidate or reduce their long positions, the banks could be caught short, literally - but they can unwind the long position by swapping back for the short. Incredible when you stop to think about it. Not supposed to work this way - another example of lax financial regulation that is causing huge distortions in world markets. Hello CFTC? Is anyone home?

WTF

The loop is impressive:

Sovereign Wealth Funds are "helping" the largest money center banks to replenish their coffers by "giving" them money which in turn is used for hedging in the energy sector, thus, increasing profits for the SWFs from this most ingenious financial arrangement.

skierwaver

Yelnick - thanks for bringing up this subjects. The articles you mentioned are interesting, and offer food for thought. And think about it I will, since I'm "overweight" in the sector.

The way I see it, if the funds will decide to decrease their long exposure, their counterparts - the banks - will merely have to cover their own corresponding short positions. Ultimately, "backwardation" and "contango" issues notwithstanding, all contract prices must remain related to the cash price -- which is determined by supply and demand.

Even if the total amount of capital committed to oil contracts (and this is true about other commodities as well) would increase overnight by a factor of 10, all those new participants would be merely playing against each other; as time goes by, the price would continue to drift towards the spot cash levels.

Trying to limit the volume of outstanding contracts - the algebraic sum of which always remains equal to zero - would not change much. Psychologically, I think, this thinking betrays an impulse towards isolationism - even if we get isolated only against participation by our own compatriots. Moreover, it reflects a certain parochial mindset - as if our government could have a decisive impact on how global markets behave. We are not the only 800 lb gorilla in the global economy.

Francis Schutte

We can't even pretend to be the test labs...this kind of situation has occured many times in the past. History and history books are the actual proof of this statement! Ludwig von Mises has exactly described what is happening and what we have to expect for the future...hence, I doubt we can call the actual rise in commodity prices a Bubble. In my opinion,it is the upcoming monster of hyperinflation!

This first stage of the inflationary process may last for many years. While it lasts, the prices of many goods and services are not yet adjusted to the altered money relation. There are still people in the country who have not yet become aware of the fact that they are confronted with a price revolution which will finally result in a considerable rise of all prices, although the extent of this rise will not be the same in the various commodities and services. These people still believe that prices one day will drop. Waiting for this day, they restrict their purchases and concomitantly increase their cash holdings. As long as such ideas are still held by public opinion, it is not yet too late for the government to abandon its inflationary policy.

But then finally the masses wake up. They become suddenly aware of the fact that inflation is a deliberate policy and will go on endlessly. A breakdown occurs. The crack-up boom appears. Everybody is anxious to swap his money against "real" goods, no matter whether he needs them or not, no matter how much money he has to pay for them. Within a very short time, within a few weeks or even days, the things which were used as money are no longer used as media of exchange. They become scrap paper. Nobody wants to give away anything against them.

It was this that happened with the Continental currency in America in 1781, with the French mandats territoriaux in 1796, and with the German mark in 1923. It will happen again whenever the same conditions appear. If a thing has to be used as a medium of exchange, public opinion must not believe that the quantity of this thing will increase beyond all bounds. Inflation is a policy that cannot last. (Ludwig Von Mises).

Sean

Yelnick, I read the John Mauldin's piece too. But I still have some confusion hoping you or the experts on this board can help.

Basically,the hedge fund manager who testified on congress (and John actually quoted from him) said that it is the ETF, and money from Retirement Funds (eg. CALPERS) that is buying the Oil and all other commodities future contracts. When the time come to deliver oil and wheat to these ETF/Funds, they simply roll over to the next month contract. In other words, they basically just go LONG and never sell.

So my question is, who is taking these physcial deliveries? I mean, if I buy 100 barrels of oil for July contract, I would expect physcially 100 barrels would arrive at my dock station. If I roll over the contract, then what happens to the oil producers that suppose to ship me tihs 100 barrels? They got to find a storage tank to store my oil on the sea?

I understand that now banks are acting as the middle man to do all these fancy swaps and listed as Commercials. But still, who are taking deliveries? Or is it possible that all the contracts "sold" (to these bankers) are actually from some other funds that went short, i.e. they don't have the real physical stocks to deliver?

Mario

Dear Sean ... answering your question regarding OIL: who are taking deliveries?

No body ... it is a plan by Saudis and other Middle East oil exporters (May be Bin Ladin & Co?). It is a closed loop they buy what they do not deliver ... it is simple. At the end we pay each day higher higher prices for what they deliver to us.

This is the result of bad political decisions ...

yelnick

Guys, this is a really inane situation, since what is happening is the speculative positions are growing to the limit of the physical positions. This is what the CFTC should never have permitted. And in the end this will all come crashing down.

skierwaver

Sean -- I've sent the link to this discussion to a person who gave all this a lot of thought over the years. The reply - in part - answers your question. here it is:

""I'm with you on this one. I don't see exactly how speculation in commodities can ultimately drive up the final price. Ultimately, the entity that takes delivery of the crude oil is the refinery. Nobody else has any use for the black gunk. Each refinery is competing with other refineries for the supply of oil thats out there. I'm not sure how any speculation in the market can ulimately impact the final price paid by the end user, which is purely a function of supply and demand.""

The way I see it, You can be long a 1000 contracts of Crude, and I can be short. Or, it can be 1 - or a million contracts, doesn't matter. Neither one of us intends to take delivery, and when time comes we'll close out our positions. One of us will make money, the other one will lose the same amount. The judge will be the cash market, which depends on supply and demand on the "physical" Oil. The point is that no matter how many contracts you and I trade, we will not have any meaningful impact - if any at all - on the price at the time of delivery.

skierwaver

Sean -- I've sent the link to this discussion to a person who gave all this a lot of thought over the years. The reply - in part - answers your question. here it is:

""I'm with you on this one. I don't see exactly how speculation in commodities can ultimately drive up the final price. Ultimately, the entity that takes delivery of the crude oil is the refinery. Nobody else has any use for the black gunk. Each refinery is competing with other refineries for the supply of oil thats out there. I'm not sure how any speculation in the market can ulimately impact the final price paid by the end user, which is purely a function of supply and demand.""

The way I see it, You can be long a 1000 contracts of Crude, and I can be short. Or, it can be 1 - or a million contracts, doesn't matter. Neither one of us intends to take delivery, and when time comes we'll close out our positions. One of us will make money, the other one will lose the same amount. The judge will be the cash market, which depends on supply and demand on the "physical" Oil. The point is that no matter how many contracts you and I trade, we will not have any meaningful impact - if any at all - on the price at the time of delivery.

KRG

SW :
The point here seems to boil down to this. (1) Does the cash market set the price and futures follow. If so we should see hugh volatility at the expiry of each futures contract when near month is squared to roll over. Or (2) is it the futures market that sets the price becos of huge liquidity and cash players who also use this market to hedge merely follow. I am inclined for the second alternative as I think the physical demand being is inelastic and deliveries merely happen at higher rates. The lowering of demand in response to high price will perhaps happen slowly. The large subsidies run by most govts are also acting against the so called demand destruction.

Yelnick : Would like to know your thoughts on this

yelni

SW - oil traders trade not the price but the basis, which is defined in various terms but essentially is the delta between the cash price and the next futures price. It represents how refineries can buy now and hedge by selling at the next price, provided there is enough margin in the basis. The basis is set with an interplay between future demand and current supply, and does not fit into your (1) and (2) above. Right now I read (I am not an expert in this) that light sweet crude is in short supply, but heavy crude is available. Problem: refinery capacity is the reverse! Hence a bit of a mismatch.

Solution to our current crisis is not much more than Volcker & Reagan did in 1982: strengthen the Dollar, raise interest rates, open up drilling, allow new refineries, and then (a new issue since 1982) close a loophole in the CFTC regs which allow non-commercial speculators to play at large scale.

Oil prices would correct fairly quickly. Long term trend appears to be between $50-75/bbl, and if the Dollar strengthens, around $42/bbl.

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