A Melman Minute
By: Leonard Melman
August 11, 2008
One of the most important questions regarding the
markets we follow, particularly as it affects the precious metals markets, is
the price of petroleum. As anyone who follows the market knows, the price of
crude soared to an astonishing (all prices US$) $147 per barrel just a few weeks
ago, but has since plunged to this morning's figure near $116.
The financial market optimists offer the view that
this sharp decline is merely the precursor to a huge correction in the price of
oil which will see that price, in fact, reverse much of the ten- year bull
market which has taken place since 1998's low of near $10.00 per barrel. Should
that occur, the argument goes, then inflationary pressures will subside,
consumer purchasing power for other goods and services will be restored,
pressure will be taken off the number of homes entering foreclosure and the
balance of trade deficit for America, a goodly portion of which is related to
the purchase of imported oil, will decline - taking pressure off the beleaguered
U.S. Dollar.
We would also offer the opinion that if the
optimistic side is correct, then there would be opposing influences on the
precious and base metals. The precious metals might be expected to subside in
the face of lower inflation and a rising level of confidence and optimism.
However, should the consumer begin to act in a more robust manner, then the
demand for base metals would likely rise as the demand for metals-related
production increased.
Those who are more pessimistic regarding oil prices,
on the other hand, point to the fact that every phase of the ten-year oil bull
has been followed by a correction, and virtually every correction has been
identified by some observers as the beginning of a new and major downtrend.
Some of the corrections have been moderate, but some have been severe, such as
the ones that saw prices collapse from $38 to $18 in 2001 and from $78 to $50 in
the second half of 2006.
Some observers have, in fact, compared the long-term
charts of gold and crude oil, coming to the conclusion that the market action of
crude in the recent era is forming a 'mirror image' to that of gold during 1980,
namely a sudden and ruthless collapse from a market which had been rising
vertically.
Therefore, it is well worth our while to compare the
two charts and form some conclusions of our own.
Please note the duration of the build-up in crude's
price which preceded the strong breakout above the $40 level in early 2003.
That pattern had lasted two decades and, chart-wise, history has shown many
examples of the move upward from a break-out being related to the duration of
the consolidation period which preceded that breakout. In the case of oil, the
world was actually undergoing a transformation where demand was growing steadily
while newly-discovered supply was beginning to diminish, altering the situation
from huge over-supply to a situation where future supply problems could be
foreseen.
Notice the difference for gold in the action which
took place before the move above $200 in late 1978. It was compact and had
virtually no corrections along the way. Then, instead of moving with slowly
gathering momentum and several important corrections, gold rapidly accelerated
its move toward the vertical and quadrupled in price within twelve months
without a meaningful reversal during its vertical move. When the rally
collapsed, it did so with incredible swiftness, dropping from about $870 to $460
within just a few trading days. Gold then spent the rest of 2000 trying to
regain lost ground, formed a second top well below the first, and then went into
a period lasting more than a quarter of a century before the old high was
finally exceeded.
There is also another important difference. Gold,
though highly desirable and, it may be argued, essential from a monetarist point
of view for the financial stability of the world, nevertheless is not an
essential ingredient of day-to-day living for the multitudes. Therefore, when
the price collapsed, there was no sustainable buying which came in from users.
The situation in crude is entirely different. Oil
is essential for day-to-day life and the fundamental equation regarding usage
versus newly-discovered supplies continues to point to supply problems through
the years. It would appear, therefore, that there is a much higher likelihood
of oil marketers taking new long positions in order to insure future supply to a
much greater extent than what happened to gold when its price collapsed.
All of this came to mind thanks to an article in
today's National Post by financial writer Claudia Cattaneo where she addresses
this very question. After pointing out that a huge difference exists between
oil market bulls who not long ago were forecasting prices as high as $350 per
barrel and bears who are looking for much lower prices, she offers this
opinion: "...bears' bet that oil is suddenly in reverse seems weak...Demand
rose in the first half of the year, reaching 87 million barrels per day (bpd).
While OECD (economically developed nations) countries used 520,000 fewer barrels
a day in the first half of the year, the rest of the world burned 1.3 million
barrels more. Most public oil and gas companies are struggling with production
declines because they don't have enough projects to replace the oil they are
producing...The peak in oil discoveries was in the late 1960s." (our emphases)
The oil question is directly relevant to prosperity
in the mining industry and bears close watching.
Markets this morning have mostly recorded relatively
small moves. As of 8:00 AM PDT, gold, silver and platinum were moderately lower
while the prices of most base metals were close to unchanged. However, despite
these quiet moves in the metals themselves, both major mining indexes have
fallen by about four percent so far, continuing their downward trend. Crude is
trading near $116 per barrel, the Dow is roughly unchanged and the TSX is off by
about 100 points. Currency trading shows the U.S. Dollar Index down by 18
points and the C$ trading near 93.75 cents US..
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