Speculative Bubble In The Oil Market?
Oil continues it’s meteoric rise this year as it passed the $135 a barrel mark earlier today. The debate has been raging whether the high prices are the result of a speculative bubble or normal supply and demand interaction.
I believe it is a combination of both factors. World wide demand has grown sharply the past few years as the developing countries become more and more industrialized. That being the case, that still doesn’t justify the more than 30% rise in the price of oil for this year alone.
Last summer, oil was trading at around the $60 a barrel range before the Fed began it’s rate slashing campaign and the dollar took a nose dive. This put a large upward price pressure on all dollar denominated assets.
Money started pouring into the commodities markets as inflation hedges at the beginning. When the stock and bond markets started falling, the commodities market offered better returns and large institutional investors also started to enter the fray.
But as world wide economic activity has slowed due to the global credit crunch, demand for oil has fallen somewhat, but the price of oil has continued to rise. While some of this is due to inflation, that would still only justify somewhere between 5-10% of the price rise since last summer.
The price of the dollar is the key to the price of oil. While the administration is supposedly in favor of a “strong” dollar policy, the Fed’s top priority remains economic growth with inflationary concerns a distant second.
That mind set may be slowly changing and it would be interesting to see what effect a rise in interest rates would have on the price of oil.
