Do we have an oil bubble?

[c1ue]

Re: We have an oil bubble : the proof

Losses on the stock market are similar to gambling - many Chinese are inveterate gamblers.

Something about that fate thing perhaps.

Unless the government can be clearly proven to have caused the stock market to collapse, I don't think losses taken while gambling will mean government instability.

At least, it didn't seem to with Taiwan, Japan, or Hong Kong as their markets lost 50% and more in their bubble eras.

[GRG55]

Re: We have an oil bubble : the proof

Losses on the stock market are similar to gambling - many Chinese are inveterate gamblers.

Something about that fate thing perhaps.

Unless the government can be clearly proven to have caused the stock market to collapse, I don't think losses taken while gambling will mean government instability.

At least, it didn't seem to with Taiwan, Japan, or Hong Kong as their markets lost 50% and more in their bubble eras.

But I believe the bubble eras in Taiwan, Japan and Hong Kong occurred at a time when the citizens of those countries, on average, enjoyed a much higher standard of living than China today. A standard of living that was well above merely meeting food and shelter requirements, and therefore the setback did not completely impoverish large numbers.

Allow hope to be destroyed at a time when so many are trying to meet the minimum requirements of food and shelter, and the situation is potentially explosive.

[c1ue]

Re: We have an oil bubble : the proof

GRG,

Actually not quite true.

For Hong Kong and Japan, yes.

For Taiwan - China is in a comparable income state in equivalent inflation adjusted dollars.

On the other hand, for Japan at least costs are also very high for food and other daily survival items.

Ultimately while no one is happy losing money on the stock market, unless they're taking on debt as in the Great Depression I don't think it is a disaster.

In China they don't do margin debt that I'm aware of.

[GRG55]

Re: We have an oil bubble : the proof

GRG,

Actually not quite true.

For Hong Kong and Japan, yes.

For Taiwan - China is in a comparable income state in equivalent inflation adjusted dollars.

On the other hand, for Japan at least costs are also very high for food and other daily survival items.

Ultimately while no one is happy losing money on the stock market, unless they're taking on debt as in the Great Depression I don't think it is a disaster.

In China they don't do margin debt that I'm aware of.

Ok so what you are telling us is that a crashing Shanghai stock market is a non-event in the overall scheme of things in China. That probably means the bubble stock market, while it lasted, was also irrelevant in the big picture? And if it comes back [the bubble I mean], then we shouldn't really be overly concerned in terms of its impact on the development of China and that region?

[BlackVoid]

Re: We have an oil bubble : the proof

Amount China pays for its imported oil subsidy
$100/barrel = $35.0B
$145/barrel = $50.8B
$200/barrel = $70.0B
$300/barrel = $105.0B

Sure, the RMB is increasing value vs. the dollar - at a 6.5% appreciation in the past 4 months = 20% appreciation in 1 year.

$105B * .6 = $63B = almost double what China is paying for this subsidy now, even with RMB appreciation of 40% over 2 years (in 2010).

And of course this expense is on top of the $245B import cost (-40%) = $147B of 'today's dollars'.

So $300/barrel oil means China has to pay $210B per year in 'today's dollars', and gasoline still would be $5.50/gallon?

And they can afford that? And the rest of the world won't be affected as well?

China can afford it in this timeframe. Their trade surplus is much larger and they also have to spend their 1 trillion of dollar reserves.
In Europe the per gallon price is already nearing $10. People complain but they still drive. Yes, the world will be affected of course, in a very negative way.

The numbers I have presented here are based on the calculation of an economist friend. In the last 2 years, his predictions were spot on. The calculation is based on:
1. the change in export (going down since 2005)
2. observed price elasticity (but modeled to increase with the price)
3. Upcoming new oil projects
4. Calculated depletion rate (growing)

From about 2010 we will have a double digit percentage decline of oil exports. That is going to hurt.

[Munger]

Re: We have an oil bubble : the proof

That kind of thinking, IMHO is completely wrong, stupid and delusional. If the ETN buyers get suddenly spooked and they all go short at the same time, the virtual-paper leverage vanishes and the whole correlation physical-paper(Nymex futures)-virtual(ETN oil) breaks down. These banks will suddently have to back gazzilions of virtual oil paper and not even the Fed can dump money so fast to save them.

Borrowing a line from Krugman, it takes two to contango. For every short bet there must to be a correlating long bet. Or am I missing some special facet of ETNs?

[Munger]

Re: We have an oil bubble : the proof

Metalman,

No one here is attacking GRG's credentials.

However, I think GRG's credential regarding an Enron style, oil derivative, new fangled pump and dump are not so strong.

We're not talking about whether there is or is not peak oil, what $#* and I are pointing out is that it is (and has been) possible to affect market prices without an actual shortage.

Only the appearance of a shortage was enough.

With Enron, with Florida land, and with tulip bulbs, all three instances were predicated on a belief of intrinsic advantage through scarcity.

There is a big factor from the three instances of bubbles that you mention that is missing in the proposition that oil is a bubble: oil is a commodity, and there can be no bubble when the spot price is nearly the same as the futures price - unless there is physical hoarding. This physical hoarding can come from artificially decreased supply or from physically storing output somewhere hidden from other buyers.

This is one point in which I agree with mainstream economists (if you want to learn more, read Paul Krugman's blog starting about 2 months ago). It was asserted by knowledgable economists that the Enron energy debacle could not be a bubble without physical hoarding because energy is a commodity. Lo and behold we found out they were creating artificial supply limits to boost prices.

I have been debating off and on whether to get deep into oil or not. The reports I have looked at indicate there is no hoarding of physical oil or artificial supply shortages: supply output has not decreased, and there is no evidence of tankers idling in the gulf. Futures prices are nearly identical to spot prices, meaning someone is taking the delivery of all that oil; and they don't seem to be hoarding it. George Soros has said, "Find the false premise and bet against it." In this case, perhaps the biggest false premise on earth is that the world is in an oil bubble and prices will eventually come back down (when's the last time you heard anyone, MSM or not, say they were long oil?).

Previous oil price spikes in the 70s and 80s all occured in times of embargo or major oil country conflict. When the turmoils subsided prices decreased accordingly. Where are the embargos right now? Where the supply shortages?

Further, if OPEC were thinking strategically in the 70s they could have lured the world into an oil addiction based on temporary surpluses to reap large benefits when prices started to spike from supply shortages. The intervening years when import countries tried to wean themselves off of oil would be windfalls. OPEC leaders said half as much in the 70s by remarking that by keeping prices artificially high they could kill the golden goose by giving the world the incentive to develop alternatives. It is only one step further to think they could keep prices artificially low to lure the world into complacence. I'm sure the guys at OPEC realized back then that Hubbard's peak was inevitable - is it possible they figured out how to maximize profits?

Am I long oil? Yes - but not in a significant way. My biggest concern is that the US, Japan and other big oil importers have been secretly hoarding oil to buffer their strategic reserves for the coming shit storm. If that is true then there could be a bubble. Again, we have no evidence, so I will probably continue to hedge.

[c1ue]

Re: We have an oil bubble : the proof

Ok so what you are telling us is that a crashing Shanghai stock market is a non-event in the overall scheme of things in China. That probably means the bubble stock market, while it lasted, was also irrelevant in the big picture? And if it comes back [the bubble I mean], then we shouldn't really be overly concerned in terms of its impact on the development of China and that region?

So far, there has never yet been a revolution over collapsed stock markets or other financial disasters.

Revolutions occur when people feel they have nothing left to lose - no food, no life, no future.

Of course there could always be a first, but I'd worry more about China's economy slowing growth to 1% or 2% before I'd worry about the stock market equivalent of Liberte, Fraternite, Egalite.

China can afford it in this timeframe. Their trade surplus is much larger and they also have to spend their 1 trillion of dollar reserves.

China has been making lots of money via trade, true, but keep in mind they have been spending equally as much money building up their infrastructure. If their current account balance corrects much, this spending is endangered, or their 'savings' will get run down.

The $1T of dollar reserves would keep things status quo for 5 years if oil hits $300/barrel, but what then?

China is not Europe - Europe has already built its infrastructure and is basically coasting. Europe can afford to be neutral in oil consumption growth - especially with a strong euro and offshoring energy intensive production to China.

For every short bet there must to be a correlating long bet. Or am I missing some special facet of ETNs?

ETNs are trading units provided by a bank. Nowhere does it say the bank MUST have physical product to back it up.

This is the point - it is not like you or I buying an oil commodity future. It is like a market maker selling stock before he has it.

[Guest]

Re: We have an oil bubble : the proof

China can afford it in this timeframe. Their trade surplus is much larger and they also have to spend their 1 trillion of dollar reserves.

Spot on BlackVoid. And also, if any one country can be anticipated to keep a positive balance of trade in the next ten years due to it's labor cost advantage, it's China. They will maintain at least some kind of cash cushion to keep subsidizing the rising oil price long after OECD countries have been subjected to the real price.

[Munger]

Re: We have an oil bubble : the proof

ETNs are trading units provided by a bank. Nowhere does it say the bank MUST have physical product to back it up.

This is the point - it is not like you or I buying an oil commodity future. It is like a market maker selling stock before he has it.

That they do not have to have physical product to back it up is the whole point - they are simply bonds that track a market for payout. Thus, the credit rating of the issuer is an explicit factor in an ETN's valuation.

An ETN is, by definition, traded on an exchange. For someone to go short, someone must be willing to go long. If everyone suddenly decided to go short or to cease going long and there were no takers for the long position, there will be cliff-diving, sure - same as when any bond issuer suddenly seems insolvent. How would this effect the price of the commodity on which the price of the ETN is based?

[metalman]

Re: We have an oil bubble : the proof

That they do not have to have physical product to back it up is the whole point - they are simply bonds that track a market for payout. Thus, the credit rating of the issuer is an explicit factor in an ETN's valuation.

An ETN is, by definition, traded on an exchange. For someone to go short, someone must be willing to go long. If everyone suddenly decided to go short or to cease going long and there were no takers for the long position, there will be cliff-diving, sure - same as when any bond issuer suddenly seems insolvent. How would this effect the price of the commodity on which the price of the ETN is based?

i'll wade in here... how can a derivative of a commodity that is structured this way effect the price of the underlying commodity? let's say i invent a derivative of gold called goldmetal that trades otc as a bet against what trader think gold is going to do with respect to physical supply/demand and spot price. one day the bank of china decides to trade all tbills for gold in a month. all the long goldmetal positions rise and the many of the shorts are wiped out. goldmetal is reacting to the gold price, and traders who used the derivative to hedge a rise won and those who used it to hedge a decline lose. but this does not impact the price of gold.

[c1ue]

Re: We have an oil bubble : the proof

That they do not have to have physical product to back it up is the whole point - they are simply bonds that track a market for payout. Thus, the credit rating of the issuer is an explicit factor in an ETN's valuation.

An ETN is, by definition, traded on an exchange. For someone to go short, someone must be willing to go long. If everyone suddenly decided to go short or to cease going long and there were no takers for the long position, there will be cliff-diving, sure - same as when any bond issuer suddenly seems insolvent. How would this effect the price of the commodity on which the price of the ETN is based?

i'll wade in here... how can a derivative of a commodity that is structured this way effect the price of the underlying commodity? let's say i invent a derivative of gold called goldmetal that trades otc as a bet against what trader think gold is going to do with respect to physical supply/demand and spot price. one day the bank of china decides to trade all tbills for gold in a month. all the long goldmetal positions rise and the many of the shorts are wiped out. goldmetal is reacting to the gold price, and traders who used the derivative to hedge a rise won and those who used it to hedge a decline lose. but this does not impact the price of gold.

You're still not getting it.

The commodity amounts - if long - in an ETN are not necessarily matched by any equivalent derivative short. The ETN is a representation of a long or short, it is not the actual position itself. You have only the issuer's word that these positions exist. In a real sense, the ETN is a derivative on top of a commodity future derivative, which in turn sits on top of a (non-delivering) commodity.

Or to put it in simpler terms: How does a Ponzi scheme work? So long as the incoming new cash is enough to pay the interest/payout promised, the appearance of lucrative gain is maintained.

However, in reality the apparent gain is being matched by an equally not apparent loss of capital - but this loss is not known until the scheme collapses.

The point about ETNs is that they could easily be a similar setup. By issuing shares of the ETN, cash comes in to buy said shares. This cash can be used by the issuer for many purposes besides the actual purchase of the ETN's underlying commodity - so long as the ETN continues to grow.

In fact besides the Ponzi setup, there are probably lots of interesting little plays that can be made using the incoming ETN share payments: for example leverage, 130/30 long/short setups, or whatever.

As for ETNs not affecting market price - I'm not so sure I agree.

So long as physical delivery for the full derivative loads are not taken, the apparent increased demand for the commodity theoretically should drive up prices.

An example:

Let's say the previous market was 100 units with price $10/unit feeding into demand of 100 units.

Someone comes into the market and offers to buy 20 units in futures and rolls this position forward.

Where before you had 100 units of demand, now you have 120 units, of which 20 units are in the form of an ETN.

But the producers of the units have the choice of selling now or selling later. The producers don't care that spot demand is the same, only that financial demand is up, and 120 units demand chasing 100 units of supply can only end one way.

[GRG55]

You're still not getting it.

The commodity amounts - if long - in an ETN are not necessarily matched by any equivalent derivative short. The ETN is a representation of a long or short, it is not the actual position itself. You have only the issuer's word that these positions exist. In a real sense, the ETN is a derivative on top of a commodity future derivative, which in turn sits on top of a (non-delivering) commodity.

Or to put it in simpler terms: How does a Ponzi scheme work? So long as the incoming new cash is enough to pay the interest/payout promised, the appearance of lucrative gain is maintained.

However, in reality the apparent gain is being matched by an equally not apparent loss of capital - but this loss is not known until the scheme collapses.

The point about ETNs is that they could easily be a similar setup. By issuing shares of the ETN, cash comes in to buy said shares. This cash can be used by the issuer for many purposes besides the actual purchase of the ETN's underlying commodity - so long as the ETN continues to grow.

In fact besides the Ponzi setup, there are probably lots of interesting little plays that can be made using the incoming ETN share payments: for example leverage, 130/30 long/short setups, or whatever.

As for ETNs not affecting market price - I'm not so sure I agree.

So long as physical delivery for the full derivative loads are not taken, the apparent increased demand for the commodity theoretically should drive up prices.

An example:

Let's say the previous market was 100 units with price $10/unit feeding into demand of 100 units.

Someone comes into the market and offers to buy 20 units in futures and rolls this position forward.

Where before you had 100 units of demand, now you have 120 units, of which 20 units are in the form of an ETN.

But the producers of the units have the choice of selling now or selling later. The producers don't care that spot demand is the same, only that financial demand is up, and 120 units demand chasing 100 units of supply can only end one way.

On the one hand the ETN is a Ponzi scheme worthless piece of paper that carries no real claim on any physical amount of commodity...

"...In a real sense, the ETN is a derivative on top of a commodity future derivative, which in turn sits on top of a (non-delivering) commodity..."

but on the other hand we are to believe that it is capable of creating real demand for physical crude [or grain, or whatever other commodity it's linked to]?

"...Where before you had 100 units of demand, now you have 120 units, of which 20 units are in the form of an ETN..."

If we go back to the CDO analogy earlier in this thread, the argument is that derivatives like CDOs created the demand for housing that ran the prices into the stratosphere in Florida, California, Spain, Ireland, Shanghai, Sydney, Dubai and of course Vancouvergoinup? The allegation is that ETNs are the "new CDO", an analogous derivative now driving up the prices of commodities to which they are indexed or referenced?

Demand for CDOs came from every nook and cranny in the world...pension funds, hedge funds, community savings accumulated north of the Arctic Circle in Norway and in the outback of Australia, German landesbanks, even the SIVs of the issuing banks themselves.

Unlike the buyers of physical houses, who needed cheaper and cheaper credit to keep the whole game going, and many buyers of CDOs, who also needed cheap credit from their prime brokers who lent the money to buy the CDOs they were churning out, who is the cheap credit supplier to the buyers of the 85 million barrels of physical liquid petroleum that gets consumed every day? Does the crude oil market [or any other commodity market] need ETNs to keep soaking up the physical supply, the way that the housing market needed CDOs? Who is the prime broker lending cheap money to the buyers of ETNs to compound the demand for them exponentially? Deutche Bank?

The ETNs I am familiar with trade on an exchange like a stock, not OTC. Who's supplying the credit to buy them in quantity? And if demand for ETNs was being gamed to such a degree, should they not all be trading at a premium to the underlying commodity [like a closed end fund]?

There is an argument to be made that off-track betting is partly responsible for keeping the price of race horses elevated. But the ETN thing is much less clear cut. I think the prime argument is that demand for the underlying commodity promotes demand for the ETN, not the other way around. If commodity prices come off in the recession/slowdown now underway the proliferation of new ETNs should first ease, and then many existing ETN instruments may be withdrawn from the market due to insufficient investor interest. If that happens it will confirm for me that these are simply a retail oriented investment "product" designed to extract fees from the ignorant, and not much more.

[Munger]

Re: We have an oil bubble : the proof

Double post

[Munger]

You're still not getting it. The commodity amounts - if long - in an ETN are not necessarily matched by any equivalent derivative short. The ETN is a representation of a long or short, it is not the actual position itself. You have only the issuer's word that these positions exist.

No, you are still not getting it. An ETN - by definition - is not backed by purchases of the commodity. "An ETN is a type of unsecured, unsubordinated debt security." (Investopedia/Wikipedia) Hence the term ETN (and not ETF). An ETN is simply a bond that some debtor issues with the promise to pay off at some value in the future that is to be determined by an index. It has absolutely nothing to do with the commodity!

Or to put it in simpler terms: How does a Ponzi scheme work? So long as the incoming new cash is enough to pay the interest/payout promised, the appearance of lucrative gain is maintained.

However, in reality the apparent gain is being matched by an equally not apparent loss of capital - but this loss is not known until the scheme collapses.

The point about ETNs is that they could easily be a similar setup. By issuing shares of the ETN, cash comes in to buy said shares. This cash can be used by the issuer for many purposes besides the actual purchase of the ETN's underlying commodity - so long as the ETN continues to grow.

The purchaser is explicitly not buying shares of a corresponding ETF! This is not a ponzi scheme because they told you exactly what they are doing. It would not be a ponzi scheme if I told you that I would pay you some amount in the future then explicitly told you that it is no guarantee that you get paid back because I am by the terms of the deal not bound to invest the money in any way - that I could go out and blow it all on frisbees - and that my creditworthiness or lack thereof is an explicit risk in the deal. If I told you all that and you went in eyes open then it is your ruin if I default by doing stupid things.

Let me stress it again in case you missed it - the value of an ETN is explicitly based on the creditworthiness of the issuer. It is not in any way hidden (except from those who do not understand what an ETN is ;)).