Sept 16th, 2008

As most of you know by now, our oil prediction in April turned out to be correct (Whew!!!) The speculator bubble has broken. In the last month Crude oil has dropped from almost $149/bbl to about $90/bbl today. The wholesale price of heating oil is down from $4.25 a gallon a month ago to $2.79/gallon today. We feel very sorry for those who panicked and went for the $4.50 plus pre-buys out there in May, June and July against our advice. Do not call us if you bought one, we cannot cancel your contract with Irving or Eastern.

Several hedge funds betting on commodities (energy) went bankrupt. Lehman Brothers bankruptcy is partly owing to their heavy investment in a couple of hedge funds betting on the commodities market.

It turns out that those who did not buy pre-buys, like OTEA members, will fare much better this year.

Is speculation behind the swings in commodity prices?

Let's use a little story to understand: say there are 1 million Mercedes Benz cars being produced annually and the same number is bought by end users. Assume now that there's a forward market in Benzes, where "investors" have suddenly "bought" for pennies on the dollar, 5 million Benzes to be delivered 12 months ahead. What's your guess where the prices are going? And what happens a year later when the 5m calls come due?

Assuming that those "investors" have rolled over or even bought many more Benzes further forward, prices will still be sky high and the winning "investors" will just be paid the difference between their contracted price and the prevailing high price. No cars need to be delivered to the speculative buyers, just a bank credit.

This game will continue like a Ponzi scheme until the number of new forwards starts to decline. Subsequently there will be a collapse of prices, back to or below the original Benz selling prices. In the meantime, the company that produces the cars will have made huge short-term profits but has to lay off more and more workers as real end-user demand drops due to unaffordably high prices.