The Oil Bubble

Crude oil prices are hitting new highs just about every day. Is the oil market in a bubble? Well, looking at the fundamentals of the oil market would seem to point in that direction. Oil and gas inventories have been rising for a while even as we make new highs in price. Consumption in the US is falling and the growth rate in places like China are lower than they were a year ago. And yet, Goldman Sachs recently suggested that oil prices could reach $200/barrel. Ronald Bailey at Reason has a good article about the reasons oil is continuing to rise:

So supply is up; relative demand is down and yet, the price of oil is soaring. What's going on? Last week, Exxon Mobil CEO Rex Tillerson blamed a third of the recent run up in oil prices on the weak dollar, another third on geopolitical uncertainty, and the rest on market speculation.

I'd say the weak dollar is the main culprit but I suppose those other items could be having an effect too. The more important question for us is whether the entire commodity complex is in a bubble. We always maintain a position in commodities in our portfolios and that is a major reason our portfolios have performed so much better than the market recently.

Mike Metz, one of the most literate and clear thinking analysts on Wall Street, has suggested in his recent commentaries that commodities and Treasury bonds may both be in bubbles. On commodities he recently stated:

This search for higher returns is being reflected in the current surge in commodity prices, which has reached bubble proportions in that levels do not reflect supply demand considerations of producers and consumers. The arena has attracted hoards of momentum traders and speculators, resulting in parabolic moves in most soft and hard commodities.

So are commodities in a bubble? I don't think so yet; if commodities were in a bubble one would expect the stocks of commodity producers to also inhabit bubble land. But the valuations on commodity producers like oil companies are quite modest. I expect that we will see a major correction in commodity prices sometime soon, but it will be that - a correction.