Why is Oil falling?

[don]

Re: Why is Oil falling?

Not disputing any of the above but there has to be a political component to oil's drop in price as well

:confused:

The non-trading general public trades daily in gas pricing.

It was an enormous fiscal stimulus for retail's critical shopping season. Not that it worked.

It turned down whatever political heat the sheeple are capable of generating.

[Supercilious]

Re: Why is Oil falling?

I love understated sarcasm.

Me too. Thanks Master Shake

Any thoughts on why the NYMEX price is about $8 less (as I type) than the Brent price? Usually it's higher. No ETNs on the Brent?

basically yes, but it's a little bit more complicated. Not only that BZ is less "indexed" but because there was a lot of noise about the Enron bubble the new CFTC rules have changed those "letters" of understanding that allowed free (reporting exemption) access from London and Dubai, and since they were canceled, it's not worth anymore to play from London and Dubai for hedging the differential in synthetic positions through Brent.

Add to that the fact that the NYMEX contract is expiring today and the new month starts trading on Monday, so you can get funny price moves at the current levels of open interest. By the middle of next week, when the Feb contract is in place probably the situation will be corrected.

Basically the current Nymex quotes have nothing to do with price discovery , but with price recovery ... from the synthetic derivatives hit

[GRG55]

Re: Why is Oil falling?

Not disputing any of the above but there has to be a political component to oil's drop in price as well

:confused:

The non-trading general public trades daily in gas pricing.

It was an enormous fiscal stimulus for retail's critical shopping season. Not that it worked.

It turned down whatever political heat the sheeple are capable of generating.

It was supposed to be a stimulus for the Republican's election campaign too [watch the pattern in election years - 2006 is instructive]. That didn't work so well this time either.

[ASH]

Re: Why is Oil falling?

A) one is my explanation from the oil bubble thread with a financial bubble anchored in commodities prices/futures . The vehicles of this financial bubble is what I call the ETN-like paper (synthetic derivatives based on commodities futures) which have very little to do with the crummy ETF/ETN's the beloved J6P buys through his e-trade account.

This ETN-like paper is traded on parallel, private and completely unregulated markets (144a OTC market) through private equity pools open only to institutional investors (dark pools). According to the latest BIS quarterly report the commodities (non gold) OTC derivatives increased in the Q2 -2008 (compared to Q1) with 56%, to a total amount of $12.6 trillion. This scam was so profitable that even the iron ore , which is not traded on any regulated commodities market was made to behave like oil, rice, copper ... well you get it.
http://www.metalprices.com/metalNews...svc=ODJ&type=1

You can think of ETN-like paper as the CDO's of commodities, but there is an essential difference. The ETN-like paper (unlike mortgage CDO's ) is a synthetic derivative, and that means the sellers/originators of this paper don't have to actually hold the underlying asset (physical commodities or futures). The paper has only to provide a return mimicking the possession of a physical commodity or another paper based on commodities (futures).

This detail allows the kings (originators) of this type of paper to pit the investors (dumb casino gamblers) against each other by netting longs against the shorts. The differential netted is hedged in futures. As a result Goldman Sachs (for example) not only makes great money by driving the price of oil to $147/bbl , but also can make another truckload of money by driving the oil price down to $35/bbl. The whole idea is to have the position differential netted against the price derivative.
The crude price of on Nymex has nothing to do with supply and demand price discovery.

Thanks for the recap. As always, I appreciate your insight and the clarity of your posts. Now comes the part where I read back what you already said (very clearly), just to make sure I've got it.

If I'm following correctly, then the "dumb casino gamblers" to whom you refer are institutional investors rather than J6P, since the trading occurs in the 144a OTC market? That implies a hierarchy of "dumbness" that goes something like J6P less sophisticated than institutional investors less sophisticated than the originators of the ETN-like paper? (Or, possibly, the originators of the ETN-like paper aren't any more sophisticated than the investors in same, but are playing a structurally-favored role in the transaction, like the "house" in a casino.)

Also, you seem to be saying that the mechanism for coupling between activity in this OTC market and the headline price of oil is through the futures that are used to hedge the differential between longs and shorts. This says to me that if there are more longs than shorts, the house has to buy oil delivery futures and if there are more shorts than longs, the house has to sell same. So, the effect is to amplify price movements on the futures market. By creating the derivatives market in oil, a larger amount of money is brought in to speculate on the price of oil than is actually associated with transactions for production and consumption... and the need to hedge the differential between longs and shorts through purchase or sale of futures transmits the "weight" of this extra money into the futures market, when speculative sentiment "sloshes" to and fro.

My takeaway is that this mechanism should lead to overshoot on either side -- overshoot on the high side when general sentiment favors high oil prices, and overshoot on the low side when general sentiment is bearish on oil.

How'd I do? Is that what you are saying?

[LargoWinch]

Re: Why is Oil falling?

I mean a fall Yes, a total collaspe...........No Way....but it has?
Mike

I don't care much that it dropped, when I see XO cognac at the duty free store selling for 33% of the regular price I buy.

Later when I see XO cognac for 20% of the regular price; I buy even more.

[Supercilious]

Re: Why is Oil falling?

Thanks for the recap. As always, I appreciate your insight and the clarity of your posts. Now comes the part where I read back what you already said (very clearly), just to make sure I've got it.

Thanks ASH.

If I'm following correctly, then the "dumb casino gamblers" to whom you refer are institutional investors rather than J6P, since the trading occurs in the 144a OTC market? That implies a hierarchy of "dumbness" that goes something like J6P less sophisticated than institutional investors less sophisticated than the originators of the ETN-like paper? (Or, possibly, the originators of the ETN-like paper aren't any more sophisticated than the investors in same, but are playing a structurally-favored role in the transaction, like the "house" in a casino.)

Basically yes. I believe in reality the situation is a little bit more complicated. The 144a OTC market is not only based on those transactions through fancy, proprietary terminals that make institutional investors feel important and special. It can be a simple threesome between a "market maker" (investment banks or big fund) and two investors in synthetic commodities derivatives: one with net long positions and one with net short position.

When you have a large pool of investors is like in a casino. Some players win and some players loose while the house (the market makers, ETN-like paper originators) always makes a profit. Not all investors in these synthetic derivatives are suckers. There are people making serious money:
- by accident (suckers who got by luck on the right side of the trade);
- astute investors (who are able to predict correctly what the "market makers" are going to do next) and
- insiders (friendly hedgies who have access to transaction flow data from the "market makers" and help those "market makers" to drive the price where they want, making a nice profit in the process)

You may say that insider trading is illegal. Yes it is... on regulated markets. On 114a OTC unregulated markets opened only to sophisticated investors who know what they are doing (like those investors with their money in the Madoff funds ).... And how would you define insider trading on a market that is exclusively for insiders?

Actually here is the interesting part. The so called "friendly hedgies" are rumored to be those hedgefunds with a very good collaboration with the market makers. If the collaboration is fabulously good, there are natural expectations the "friendly hedgies" will always be on the winning side of the trade, no matter what the markets are doing, or where the oil price is going etc.

I have the impression (which may be completely wrong) that at least some of the investors in the Madoff funds, did not buy for a moment the line that the "split strike conversion" was the real source of profit. I believe many assumed (rightly or wrongly) that Bernie was running his own "friendly hedgie" operation on top of his legitimate market maker desk, basically ripping off all the other small "unconnected" and "unsophisticated" investors for the benefits of his own friendly hedgies. Those investors in the Madoff funds may have though the "proprietary trading strategy" was just the bullshit cover necessary to give the SEC a good reason not to investigate an insider trading operation.

Basically some of the Madoff investors believed they can get 16% year after year just for providing a cover for Bernie to rip off the small investors of his market maker desk on the benefit of his own friendly hedgies.

In this case, details about keeping ostensibly the trading floors completely separated form the small, hush-hush investment hedge operation, the absence of the usual 2-20 pattern in Bernie's funds and the willingness of all investors to abandon due-diligence and audits, suddenly makes a lot of sense.

Another interesting thing is that, any Ponzi scheme has to have an exponential pattern of growth otherwise it collapses. That's why Ponzi schemes can't last for long. What is intriguing, is that the supposed Ponzi scheme run by Bernie lasted for a surprisingly long time, and from what I've gathered it was not a clear exponential growth.

Hypothetically speaking, it may be possible that Bernie was running a friendly hedgie operation on top of his market maker business, which somehow got out of control. A black swan or simply the fact that the market maker business didn't have enough victim-investors trading through Madoff created a situation there were the friendly hedgies had nobody to leech than ... themselves. Since Bernie as not able to unwind the friendly operation in time, or he hoped to gain time to restart the leeching process, it degenerated into a Ponzi scheme.

I hope the SEC will do a very thorough investigation in this matter and if the investigation finds there was a big friendly hedgie operation going south into a Ponzi scheme, maybe further investigations will reveal if the rumors about all market makers running such operations are correct.

But let's go back to the oil thingy...

Also, you seem to be saying that the mechanism for coupling between activity in this OTC market and the headline price of oil is through the futures that are used to hedge the differential between longs and shorts.

Basically yes, but in some cases the hedge is done directly through OTC contracts with suppliers/consumers, like it happened with the iron ore, when the Chinese had to agree to a 96% in the price of the iron ore they were importing from Rio.

This says to me that if there are more longs than shorts, the house has to buy oil delivery futures and if there are more shorts than longs, the house has to sell same.

Basically yes, or it has to use the help from friendly hedgies to suddenly reverse positions and fry all the guys who previously made money by following the trend.

So, the effect is to amplify price movements on the futures market. By creating the derivatives market in oil, a larger amount of money is brought in to speculate on the price of oil than is actually associated with transactions for production and consumption... and the need to hedge the differential between longs and shorts through purchase or sale of futures transmits the "weight" of this extra money into the futures market, when speculative sentiment "sloshes" to and fro.

That is true only if the futures hedging footprint is much smaller than the cumulative weight of the real commercial hedgers plus the classic straight forward speculators.

If we believe that most of the "commercial hedgers" are actually OTC 144a hedgers (haven't seen yet a Goldman Sachs gas station or a Morgan Stanley refinery), one may think that about only 10% of the money on the futures market belongs to real commercial hedgers and classic futures speculators. In this case there is no slosh because the synthetic derivatives hedgers are actually the ones determining the price evolution. or as GRG55 put it metaphorically:

"Goldman Sachs is short oil; and whatever Goldman wants, Goldman gets [Newton's 4rth Law of Motion and Markets]"

My takeaway is that this mechanism should lead to overshoot on either side -- overshoot on the high side when general sentiment favors high oil prices, and overshoot on the low side when general sentiment is bearish on oil.

Or in other words the oil price has nothing to do with supply and demand price discovery.

I guess we are witnessing history in the making because these synthetic derivatives have created the first negative bubble (making money through a self-reinforcing process of price decrease).

Should will call it anti-bubble, short bubble... double, rubble, ruble? :eek:

How'd I do? Is that what you are saying?

Let's say ... more than adequate ...

[FRED]

Re: Why is Oil falling?

I guess we are witnessing history in the making because these synthetic derivatives have created the first negative bubble in the the history (making money through a self-reinforcing process of price decrease).

Should will call it anti-bubble, short bubble... double, rubble, ruble? :eek:

Very good information, thank you!

There are precedents for anti-bubbles, such as the one that suppressed the oil price from 1980 until Iraq War II, during the heyday of the Global Dollar Cartel.

[Supercilious]

Re: Why is Oil falling?

Very good information, thank you!

Thank you Fred.

There are precedents for anti-bubbles, such as the one that suppressed the oil price from 1980 until Iraq War II, during the heyday of the Global Dollar Cartel.

That is absolutely correct. I have to rephrase: we are witnessing the first financial bubble anchored in (drawing momentum from) a self-reinforced decrease in the price of an asset. I believe that these synthetic commodities derivatives have creates something completely surreal.

[c1ue]

Re: Why is Oil falling?

$#*,

An interesting exposition.

However, the next step needs to be taken: what is the mechanism whereby either the acceleration of trend mechanism is broken or goes parabolic?

[Down Under]

Re: Why is Oil falling?

When you have a large pool of investors is like in a casino. Some players win and some players loose while the house (the market makers, ETN-like paper originators) always makes a profit.

...

Or in other words the oil price has nothing to do with supply and demand price discovery.

Very good post; I can't say I follow it all but I believe the bottom line is correct, that is, "the oil price has nothing to do with supply and demand price discovery".

And, if it is correct, that is, the price discovery mechanism is broken, it's just a financial casino as you state. Again, this is consistent with Satyajit Das' assertion in "Traders, Guns & Money".

Can the US & the world's financial system recover whilst a large part of it is basically a gambling casino?

And surely, this must be the case with other commodities too, not just oil?

[GRG55]

Re: Why is Oil falling?

Anybody ever remember seeing a $7.00 contango on the forward month? Moe??

Here's the quote for NYMEX WTI:

Jan-09	34.76
Feb-09	42.25
Mar-09	45.35 *
Apr-09	46.44 *
May-09	48.13 *
Jun-09	49.52 *
Jul-09	50.69 *
Aug-09	51.66 *
Sep-09	52.54 *
Oct-09	53.31 *
Nov-09	58.94 *
Dec-09	55.60 *

[In other words be careful about assuming everyone is selling their oil at a WTI reference below $40 as Bubblevision would have you believe]

Today's closing figures for the NYMEX WTI crude curve [note $#*'s previous point-out that today was the final day for trading on the January contract] Columns show close price and the change. For those wondering why global oil inventories are swelling, it's the contango more than demand destruction that is governing. It pays the traders to hold inventory, and this happens every time the market goes into contango. In other words, if the curve was backwardated [which is the historical "normal" situation] the declining demand would be met with more production curtailment than we are witnessing presently [it's cheaper to "store" the oil underground in its native reservoir than produce under that circumstance].

Jan-09	33.87	-2.35
Feb-09	42.36	0.69
Mar-09	45.16	0.77
Apr-09	47.15	0.71
May-09	48.74	0.61
Jun-09	50.05	0.53
Jul-09	51.15	0.46
Aug-09	52.06	0.40
Sep-09	52.90	0.36
Oct-09	53.71	0.40
Nov-09	54.50	0.46
Dec-09	55.28	0.52
Jan-10	55.97	0.52
Feb-10	56.65	0.52
Mar-10	57.31	0.52
Apr-10	57.95	0.52
May-10	58.58	0.52
Jun-10	59.16	0.52
Jul-10	59.72	0.52
Aug-10	60.28	0.52
Sep-10	60.83	0.52
Oct-10	61.33	0.52
Nov-10	61.79	0.52
Dec-10	62.23	0.52
Jan-11	62.63	0.54
Feb-11	63.02	0.56
Mar-11	63.40	0.57
Apr-11	63.77	0.58
May-11	64.12	0.59
Jun-11	64.44	0.60
Jul-11	64.73	0.61
Aug-11	65.00	0.62
Sep-11	65.26	0.63
Oct-11	65.51	0.64
Nov-11	65.74	0.65
Dec-11	65.97	0.66
Jan-12	66.21	0.68
Feb-12	66.45	0.70
Mar-12	66.68	0.72
Apr-12	66.91	0.74
May-12	67.13	0.75
Jun-12	67.34	0.76
Jul-12	67.52	0.77
Aug-12	67.70	0.78
Sep-12	67.88	0.80
Oct-12	68.06	0.82
Nov-12	68.24	0.84
Dec-12	68.42	0.86
Jan-13	68.60	0.86
Mar-13	68.96	0.86
Jun-13	69.48	0.86
Oct-13	70.15	0.86
Nov-13	70.31	0.86
Dec-13	70.47	0.86
Jun-14	71.41	0.88
Dec-14	72.31	0.90
Jun-15	73.20	0.91
Dec-15	74.04	0.92

[goadam1]

Re: Why is Oil falling?

Won't cheaper oil be a small beginning of a virtuous cycle in cheaper prices. Won't the "savings" be spent on savings and demand?

[Supercilious]

Re: Why is Oil falling?

Can the US & the world's financial system recover whilst a large part of it is basically a gambling casino?

Of course it can. If US wanted to get rid of Las Vegas Casinos it was enough to arrest the Godfathers who were the owners of those Casinos, or just to use law enforcement to scare them out of illegal gambling as they do in other states.

The problem is that if hypothetically you would have had a member of the Cupola head of the Justice Department (which like the Treasury Department is an arm of the US government), and the government would grant a monopoly of making rules and taxation of commercial activities to a commission of Cosa Nostra representatives, creating therefore a hybrid government-private monopoly (as the Federal Reserve System is) it would be very difficult to restrict illegal gambling.

Moreover, I'm sure that even devout Jehova's Witnesses and Muslims, who do not gamble, would be forced to pay most of their disposable income (and loose their 401k's in the process) to build and create cash flows and profits for new and more sophisticated casinos and rackets.

Of course, that in order to extort more gambling and racket taxes from the hard working people hwo never gamble the deep captured officials would tell them that casinos are too big to fail and have to be rescued because the economy would collapse.

And surely, this must be the case with other commodities too, not just oil?

All commodities were "indexed", including those not traded on futures exchanges such as the iron ore.

[Basil]

Re: Why is Oil falling?

That is absolutely correct. I have to rephrase: we are witnessing the first financial bubble anchored in (drawing momentum from) a self-reinforced decrease in the price of an asset. I believe that these synthetic commodities derivatives have creates something completely surreal.

Thank you for your explanation, fascinating! So what are scrubs like us who continue to try to play shifts like this to do? I bought USO at 33 today, but a small position, so that I can ride out further downward momentum. But I fully acknowledge that I am playing in an arena about which I know very little. Are there any indicators we should look for that might indicate this particular bubble is set to unwind?

[Jim Nickerson]

Re: Why is Oil falling?

Thank you for your explanation, fascinating! So what are scrubs like us who continue to try to play shifts like this to do? I bought USO at 33 today, but a small position, so that I can ride out further downward momentum. But I fully acknowledge that I am playing in an arena about which I know very little. Are there any indicators we should look for that might indicate this particular bubble is set to unwind?

Symbols can give you his answer. Here one answer. In my mind there is no question that oil is oversold, as is USO. The unanswered question is will it become even more oversold? I don't know. Buying things during drops is called "catching a falling knife." The problem with buying things in a downdraft is no one, I don't think, knows where the bottom is. As long as you are buying with prices dropping, I believe your are hoping to pick or catch the bottom. You might be lucky and catch the bottom, but I never do.

Look at a chart of USO http://stockcharts.com/h-sc/ui?s=USO...49&a=137304521

Though there have been two or three upmoves since July, none have gotten back to the 50 DMA. Wait for enough strength to occur to get the price up to the 50 DMA and assess then what seems to be going on with the ecomony, interest rates, dollar, etc.

If oil is going to resume a serious uptrend which I think it will at some point (when I don't know), then whatever is missed out on the move from the low to the 50 DMA or thereabouts will in the long term be insignificant. I guess one could use that argument and say buy now, and any further losses from here will be insignificant, but what if oil does ends up dropping into low 20's or high teens--that could be a 35% loss or more from today's close, which would then take a ~60% or more gain to get back to even.