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The commodity markets need speculators to function. However, up until 18 months ago or so, the speculators in the pits were lightning fast, trading gun fighters working a zero sum game of which only the best and brightest survived. They traded their own funds or were professionals trading companies' funds and had to post substantial capital to trade at all. The other traders were the "real" people, the producers and users of the comodity. That happy picture has kept us in product/demand balance for 25 years at reasonable prices, taking oil as an example.

What changed is ETFs where anybody can trade oil like a stock with no stake other than the cost of the security. You have the big retirement funds allocating a portion of their investments to commodities that was never done before because the risks of active trading are so high. Many "investors" really rely on their advisors to invest and the mantra today is "diversity" which, for the first time ever, can include direct participation in commodities. What you have as a consequence is a huge avalanch of money pouring into a relatively small market. Although you can trade either the long or short side of oil using ETFs (DIG and DUG for example) this is very dumb money flowing into the markets and the hype and religion is all on the long side. If you hear the commentaries of the trading professionals, they are riding with the tide and contributing to the upside money flow. Typical comments are that they ignore fundamentals because they are meaningless in the oil markets. They only use charts. The trend is indeed their friend.

The producers are mystifyed by the price of oil, even though they benefit from it on the short term. They are particularly puzzled by the claims of supply/demand impbalance as they are able to fill all orders and even have full tankers that they cannot dispatch immediately.

There is no supply imbalance. What is happening is that we are tapping more expensive sources of oil and what is definitely true is that the age of cheap oil, $10-25 a barrel is over. The Canadian oil sands are just coming on line with reserves on the scale of Saudi Arabia's. Production costs are about $65 a barrel. If you throw in about $10 a barrel gross margin, $75 is probably the current peak balance point for supply/demand. Folks get hysterical about miscule movements in US inventories when those are largely driven by trading technical factors, like the ratio of the spot to future prices. If there was a supply demand problem, believe me you would know it. Very bad and very visible things happen.

So who do we punish for all of this? The little guy who is blindly following his advisor's direction? CALPERS? The root cause of this was the creation of commodity ETFs which have had huge and catastrophic unintended consequences. There are hints of malfeasance as well with private deals, collaboration and so on which no doubt exist anywhere there is money flowing on this scale. That is not the cause of this issue.

The hard problem is what to do about it. How do you unwind the ETFs without killing the innocent? Unfortunately, there is no avoiding that any more than with the technology stocks (the whole world is the Internet-you can't lose with technology) or housing (they aren't making any more land, you know) or oil (it can only go up because we are running out of oil). Barron's ran a front page story on how pecarious this trading imbalance is and said that oil could well come crashing down to $120 before the end of the year. I have heard others talk about a "correction" to $100 a barrel. Both those scenarios are unlikely. If the market starts down in a rush, everyone will attempt to get out at the same time, including the producers and the selling will be massive and uncontrolled. We are most likely to go way down, probably below $75. Our pidgeons, the true believers, the dumb money will get taken out yet again. The market will be as irrational on the downside as it has been on the upside or more so. There are many psychological studies that show that human beings are much more strongly effected by loss than gain in investing situations and the excesses that follow.

Given that big crash scenario, it would be the correct political move to eliminate commodity ETFs as a post bellum garbage collection operation.

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