This Model Perfectly Explains the Recent Oil Price Swings
March 28, 2017
•2 min read
One of the things we learned when oil collapsed a couple of years ago—something I’ve written about previously—was that there was a positive feedback loop embedded in declining oil prices.
Basic economic theory would tell you that as the price declines, so does oil supply. But the opposite turned out to be true. The price went down, and people pumped more!
Take a look at a chart of WTI.
See how oil takes a while to go up, but goes down in a hurry? Traders call this “going up on an escalator, down on an elevator.”
But this isn’t usually the case with commodities. The high-velocity move tends to be to the upside—especially given geopolitical risks. Iran does something bad, and the price of oil gaps up three bucks.
The Price Action Has Totally Reversed
Oil has been in a bear market for a while now, and just because it bounced from the panic lows does not mean that the bear market is over.
Disclosure: I am a bit of a permabear on oil. It’s easy to be a permabear on commodities. Being a bear on commodities is like being a bull on the human spirit.
Back to oil. We literally have it coming out of every orifice because of human ingenuity. Because of one very simple invention: learning how to drill sideways. Do you remember your elementary school textbooks that said the world would pretty much be out of oil by the 2000s? That we only had 20–30 years left? Those textbooks told me we would run out of oil in our lifetime.
Bzzzt, wrong answer.
Now we have a few hundred years’ worth. My guess is that it will last longer than that. As for alternative energy, we will use it when it gets cheaper than fossil fuels and not a moment sooner. I have no position in oil, but on balance, my portfolio stands to gain if it declines further.
Gasoline is cheaper than water. Does that make you mad? It shouldn’t. It should make you stand there, mouth wide open, and gawk at the miracles of capitalism.
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Jared Dillian
Jared Dillian is the editor of Bull’s Eye Investor, an investment advisory that uses a top-down approach and macroeconomic analysis to identify profitable investments, with a particular focus on behavioral economics. Bull's Eye Investor is a Mauldin Economic publication.
Before joining Mauldin Economics, Jared Dillian had a successful career as one of Wall Street’s preeminent risktakers. He started his financial career as a clerk on the floor of the Pacific Options Exchange, where he fetched lunch and ran risk reports and learned everything there was to know about the derivatives markets.
After receiving his MBA from the University of San Francisco, he traveled to New York to become a trader for Lehman Brothers. He worked there from 2001 to 2008, bookended by 9/11 and the bankruptcy, first as an index arbitrage trader and then running the ETF desk for a number of years. Under his leadership, Lehman’s ETF effort grew to be number two on the Street in terms of market share and was routinely trading over $1 billion a day in volume.
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