As 2008 rolls on, we are continuing to see crude oil’s meteoric rise as well as the direct and indirect harm that this trend is causing. Not only are certain industries with end-products or services dependent on crude oil (transportation, plastics, etc.) feeling their margins squeezed, but there is also an increasing fear that broader inflation is being sparked. So far consumer prices have only inched up, though that serves little or no indication of what is to come.
Photo:Jouni Lehti, Creative Commons, Flickr
The scary part is that we are in uncharted waters here. Each day, I read differing points of view of how commodity prices have risen and what that means for the broader economy and how our future lives will play out as a result. There is similar uncertainty among the investment community. Can inflation significantly derail the progress we have made in recent times? Investors seem to think so, as inflationary fears this week have wiped up much of the S&P500’s gains this year. Personally, I think if crude oil continues its surge broader inflation will finally become a noticeable problem. We have, by and large, escaped that predicament thus far, but it can’t last forever.
What should be examined in closer detail here is how and why crude oil prices are continuing to rise. Some claim that it is a result of the weak dollar and that investors are pouring their money into commodities such as oil as a hedge. Others say that, due to rapid global economic growth, oil is becoming increasingly scarce and hence becoming more valuable. A third (and the most popular) opinion involves a combination of the two. With new oil discoveries becoming less and less common, does that mean that oil prices will continue to accelerate at insane rates?
The now (in)famous Goldman Sachs (GS) analyst Arjun Murti thinks so, as he has boldly predicted that oil will hit $200 per barrel this year. Sound preposterous? Well, this is the same gentleman that predicted oil would reach $100/barrel back in 2005, when it hit a temporary high of $58/barrel. Critics and upset investors lashed out at Goldman, even going as far as accusing the firm of manipulating the market to benefit its own energy trading desk. Come 2008, the same critics sheepishly backed into their respective corners. Mr. Murti had the cajones to make such a prediction and now he has gained the respect of all his peers. And oil prices continued to rise.
We have seen careers advanced to the next level because of seemingly outlandish predictions that eventually became true. Meredith Whitney, the sultry financial services equity analyst for CIBC World Markets, correctly predicted back in October 2007 that Citigroup (C) would soon slash its dividend, and now she seems to move markets with every call she makes. Joe Namath, the former quarterback for the New York Jets, boldly predicted that his team would upset the mighty Baltimore Colts in Super Bowl III, even as 19-point underdogs. He then went on to a Hall of Fame career.
Is there a method to Mr. Murti’s "madness"? Will his claim come true again? No one has proved him wrong but I have my doubts. Is the U.S. dollar going to stay depressed for that long, prompting investors to continue to pour money into oil? And after a 30% price rise in less than three months, have the supply/demand fundamentals of oil been proportionately out of whack to support that rise? And even further, will these imbalances continue to send oil all the way to $200/barrel before the year is out? I vote no, and in fact, I will make the bold prediction that oil will hit $100 before it hits $200. I think there is a massive bubble building, and while I cannot predict exactly when it will burst, I believe it will be before the $200 threshold is reached. Let’s hope that I am right.
Disclosure: I do not own shares of GS or any oil company. I predict that it it will be a while before I own shares of Citigroup, and that the New York Jets will not win Super Bowl XLIII.