If you are related to the field of finance in any small way .. u cant ignore but discuss about one instrument which could have made a jackpot for you this year. No prizes for guessing that this instrument is 'Oil'. Yesterday (friday - june 6th) saw highest intraday move for oil .. the price was $138.54 up 8.41% to a life high!
Now the question is who would buy oil at $138.54 a barrel? and most important who brought it upto $138.54 a dollars? .. answer to both these questions is not only difficult but devious. Here is just a possibility of reasons which have led to oil price explosion.
If you recollect; just recently Calpers had decided to increase its global allocation to commodities and so did other pension funds and endowments. An increase in unemployement rate; decelarating US economy and global infaltion fears have prompted these pension / endowment funds to re-think their asset liability mismatch. To the extent now that US interest rates trade at a negative real yield and fear of losing substantial capital through inflationary pressure has spurred a huge investment demand for oil. As we all know that only commodities serve as an anti-inflationary hedge; investment demand for Oil, gold and other soft commodities will continue to rise. Fact of the matter is oil is not a replacable input into industrial production; and a stable production demand coupled with this investment demand is spuriing up oil prices. Even if the global growth rate was to go down 2% this year and assuming 50% industrialization of growth; the demand for oil would be down just 4% ( 2%/50%); however, the investment demand has already covered up this difference. This is now becoming a problem for economies with current account deficits; as widening deficits are leading to currency devaluation which turns into a higher cost of input and further an inflation which is impossible to contain. And the mother of all problems is that no one can dare raise interest rates now to contain inflation as the financial market is already in midst of an impending credit distress. Any weak data now is an impetus for commodities like oil and there is no reason why Oil can't reach $150 in a months time.
Second reason for this spree in oil price is less of an issue but still a cause!... Being into the structured products world; i remember that during jan/feb/march many of the investment banks were engaged in selling Structures on oil which profitted from a fall in oil price. Infact one of the ideas we sold to our client was shorting Oil at $117 when the spot was $90; I am glad we didn't sell this one to our client. Such structures were caught by the investment demand mentioned earlier and resulted in a Bear trap. When these structures were squared off eventually it resulted in a price push to an already inflated price.
On the supply side nothing much has changed and to be honest nothing much has changed in terms of the real demand for Oil. However, we have just added two more dimensions to the demand-supply balance; Capital Protection (investment demand) and Leveraged trading (structured products) and unfortunately both of these are on the demand side of things.
There is reason to believe that this price of oil has no fundamental justification .. however I cant be sure to short Oil till the I know some god father has raised interest rates; killed inflation (or alteast put it to bed); our investment banking friends have sqaured their structures and most importantly there is investable real yield avaliable for pension funds in the markets.
Stay Delta nuetral! (Long Straddle)
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