Monday, June 16, 2008

Hoarding Or No Hoarding?


VERITAS said... "Collectively, these funds have stockpiled (long on inventory via the futures market) 1.1 billion barrels of petroleum. It’s not like they are actually going to take delivery of these oil barrels, but their stockpiling is tantamount to hoarding 1.1 billion barrels from the real market place. If real supply is constant, one can imagine what the 1.1 billion long positions will do to oil futures prices if they are rolled over."

For every buyer of a contract in the futures market there is a seller of that contract. So who are the sellers ?
Right now, the buyers are collectively 'stronger' than the sellers being reinforced by the entrants of new bulls attracted by the seemingly inexorable rise in price. The tipping point will come when price stops rising and the sellers become collectively 'stronger' and attract new recruits to their camp. The futures market is just a tug-of-war between buyers and sellers. There is no hoarding of 1.1 billion barrels from the real market place.

Salvatore_Dali said...

Veritas,

Yes, there can be hoarding because your argument that for every buyer there is a seller of the futures contract does not hold water. If your argument holds water, then there will be no px movement as buyers always equate corresponding seller side?!!

I give you a simple example, lets say there were 20 contract players to start and 10 on buy and 10 on sell, willing buyer willing seller a price of $50.00 was achieved. Next month there were another 20 players, same sized, but 15 were buyers and only 5 sellers... the px would have to adjust to that demand supply. Now there are 10 +15 buyers = 25 buyers. Sellers 10+5 = 15. To match, there has to be an additional 10 sellers, which will come from the buyers taking profit at higher levels. Thus all equal.

But no, the 10 long players who took profit returned in the next month as long players as well. The 25 buyers from previous month stayed long. Then another 20 new contract players come in and 15 were buyers only 5 sellers.

Thus now we have 10 who took profit n came back long. You have 15 who kept rolling and adding to positions and you have another 15 new entrants who went long as well. You have 40 long players and 5 genuine sellers. To satisfy the demand and supply the price has to rise for the longs to consider selling.

You can do the math. The higher the price then there could be speculation on the short side. Some hedge funds could take huge bets that the oil price is a bubble. Hence they went short the next month, however the rolling over of longs plus the deluge of momentum players caused a short squeeze, and the hedge funds cut their losses and bought back, its a spiral.

In a properly functioning market if a price is irrational, the sell side would increase. However, in this case the genuine sellers are the producers and they thought US$110 was a very good price to sell. Now they have nothing to sell for the rest of the year. They can only sell naked, a naked short, which will have to be covered if price moves up some more. The problem is compounded because there are no more natural short side. Those on the short side are getting less and lesser by the day. The only shorts available are those who were long and wanted to take some money off the table.

Hence this may be a very different kind of speculators, the long term kind, who by right should be regarded as investors since their time line is so long.

The ones keep going long are basically hoarding... if not how to corner the gold, silver, tin markets in the past... They never sell. Why they never sell, well if u r diversifying a US$10bn portfolio... u want maybe 15% in commodities, hence no need to sell, and u should not sell a diversification move, its not a trade.

The many ETFs and long only commodity funds launched are are not end consumers. None of those who go long are. The sellers in this equation: oil producers, they sell n they regret the next month, could have sold higher. How can u say there can be no hoarding.

Hoarding means increasingly stockpiling WITH no intention to consume the commodity.

Veritas added: I n the Silver Bubble of yesteryears, Nelson Bunker Hunt initially hoarded the futures contracts, which shot through the roof. I believed he then became greedy,enlisted the participation of the Saudis, and started taking delivery of physical metal to push the price even higher. LME stepped in, changed the rules and the music stopped.

p/s: photo: Charlie Yeung

5 comments:

VERITAS said...

There is no hoarding of 1.1 billion barrels of physical oil from the real market place. What is being hoarded is 'virtual oil' in the form of ever increasing open interest in the oil futures market, through continued rollovers.
"WHO ARE THE SELLERS ?" was intended to elicit your view, and I am glad that you have responded. I am completely in agreement with your view that the SHORTS are the producers selling forward. Any other group of SHORTS would have been devastated, and would have capitulated by now. There has been a lot of conjectures and analysis of who the LONGS are, but hardly anything on the SHORTS. If the producers are on the short side, they would be sitting on a massive unrealised loss, even as they rake in higher revenues in the real market. They would be the ones to burst this bubble. What will the Saudis say on June 22nd ?
In the Silver Bubble of yesteryears, Nelson Bunker Hunt initially hoarded the futures contracts, which shot through the roof. I believed he then became greedy,enlisted the participation of the Saudis, and started taking delivery of physical metal to push the price even higher. LME stepped in, changed the rules and the music stopped.

globevestor said...

Will gold be the next target of commodity speculators since it is being traded worldwide? Can someone 'spin' it that even oil price is correcting, real interest rate is still negative?

solomon said...

When you are producers and starts to hedge, you are still OK as you might have stock to deliver. However, if you are pure speculators/investment houses without physical stock, I bet you cannot recover if the price drops drastically as you need to cover the shorts.

Speculators are betting that shortage of oil supplies(eg disruption in oil supplies due to natural disaster or no new major oil finds).

So when the game controllers make enough, it will be the END. Speculators, I think you better take parachutes now. Or else, run the risk of having sleepless nites if there is sudden switch of fund flows from commodities to equities.

ONI said...

This is great.

I've always wonder how px works on this zero-sum game. Now I understand more. Thanks for sharing your knowledge guys.

Opine said...

I tend to agree that most everyone is in a market be it futures or equities to make a profit.

Both views that the prices for a particular commodity or product will go up in prices or down are equally compelling as one can make equally logical arguments for either side.

Let me put my two cents into where I think this is all going.

In the short term you may be right that crude in this sense is heading down due to new regulations by the powers that be.
This is not necessarily a good thing , as this may provide the incentive for huge funds to move to other exchanges(Dubai), or move into other markets and cause a new 'bubble' thereabouts. A vicious cycle if ever there was one.

However I think prices are moving up due to a fundamental supply-demand issue. Namely there is more demand for crude even at this so called expensive(unsustainable?) prices.

I support this by pointing to some stats that show that growth, while it is slowing down in the US and parts of EU, is still happening in emerging countries, china as a prime example.

Overall worldwide demand destruction is not happening fast enough for crude to drop and maintain a lower price.(not that the price may not drop and be volatile, just that it will in no way stay that way) Oil is not running out yet, just that cheap oil is.

The immense amount of money sloshing around can move markets and my bet is that huge long term low risk funds are now looking to put a higher weight of their portfolio into commodities as they seek to disperse the risk from the traditional markets, namely fixed incomes and equities.

Ultimately, I think the prices will be higher for oil and that it is a good thing because it forces people to look at alternatives such as solar, wind, nuclear, hydro etc. We need renewable sources of Clean energy now more than ever.