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February 21, 2006

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Futures...An Economic Field of Dreams
Name: Phil Flynn

Company: Alaron

Learn More About Today's Author
Years Trading: 19

Favorite Movie: Patton

Futures...An Economic Field of Dreams

Since the Reagan years, economists have spoke of the beauty of supply-side economics. Cut taxes and they will build it. Maybe not a baseball field in a cornfield but they will build something, somewhere, a building or maybe a business or whatever. And along the way they will provide jobs and increased economic growth and increased tax revenue as a result. Now some economists may have issues with supply-side economics despite the fact that it has been proven to work time and time again yet no economist would have a problem with the old definition of supply side economics. Because in the beginning the real law and basic truth of supply side economics was whether you have enough supply to meet demand. And the search for that age old question is the stuff dreams are made out of. Or maybe fortunes.

Of course, for the futures markets, the new millennium has been an economic field of dreams. The US economic expansion continues to fly high. The Economy was spurred out of an inherited recession by the Bush tax cuts, spurring incredible growth and demand for goods and services. This growth has spurred economic expansion in many parts of the world, and in doing so, has caused a huge spike in demand for hard commodities all over the earth. China has been a major beneficiary of the US economic expansion. China, of course, has been undergoing its own industrial revolution. By supplying the United States goods to meet its demand, China has experienced incredible growth. This growth has also expanded to India, which has fed China with goods. And underneath it all it has spurred incredible demand for commodities across the board. Not only to make goods for others, but for their own comfort and appreciation.

Yet recently the incredible run in commodities seems to have lost its momentum. After its impressive run in recent weeks the hard commodities have been hit with some hard times. Sure, gold, silver, platinum, copper and oil all hit either all time highs or at least multi- year highs, but recently have seen some wicked corrections. Investors of course might wonder if the run is over and whether or not they have missed the boat. Is the great Commodity run over, or has it just begun?

They say of course that the best cure for high prices is in fact high prices. When prices are high, supply sometimes seems to materialize out of no where. Or at certain prices levels, alternatives are searched out and we seem to shift from tight supply to oversupply. Sometimes this can take a matter of months and at other times it can be a matter of years.

The question you really have to ask is what it will take to correct the supply and demand imbalances that have caused the recent run-up in price. And in what period of time will it take to catch up to the incredible demand growth we have seen in recent years. What is the upside when it comes to places like China, India and other developing nations? Will the world be able to keep up feeding their insatiable appetites, or will their growth moderate speeding up the inevitable surplus of supply. It seems based on recent market movements that the high prices have increased supply enough to stop the unrelenting buying, but the real question is whether this is a short term fix that will lead to an extended downtrend or is it a break in price and an abundance of material that will spur another round of buying and demand.

What will it take to correct the supply and demand?

Let’s take a look at oil for example. Oil has risen to all time highs on hurricanes and crazy weather and tight supply, yet more than anything has risen due to strong economic growth. But after the storms, a dip in demand and oil released from the world’s strategic petroleum reserves seems to have alleviated tight supply. In fact, based on the recent oil inventory reports, if you take them at face value one would think we would have enough supply to last a lifetime. In fact if you read the headlines, you would think the supply of crude is overwhelming and should if things stay on this path we will see a glut of crude that can actually stager the inanition, a glut that could cause a price crash of mythic proportions. And despite the huge dramatic correction from the highs, it’s probably not an indication the bull market in oil is over. Because when considering the price of a commodity not only do you have to worry about the supply side, you have to focus on the demand side as well and whether or not the supply can keep up with that demand.

The oil market is an easy-to-relate-to economy as every one has felt the effect of these rising prices. Oil supplies have risen to a seven year high, and given that fact one might assume that oil prices should actually collapse. And there is no doubt that that information has brought the oil price down dramatically from its high. Just in January of this year oil came within a dollar and a few dimes from its all time high set after hurricane Katrina only to correct back down hard on reports on increasing supply. Yet when we analyze that even though oil supply is at the highest levels in seven years, the demand for oil has grown dramatically in the last seven years. And we also have to remember that to get supplies to these levels, world oil producers have had to pump oil at a near record pace.

In fact, demand for oil has grown so much that the world’s oil producers have struggled to keep up. Indeed it has been the lack of spare production capacity against this backdrop of rising world demand that has driven prices higher and higher. After the recent drop in price, OPEC, which has been pumping oil all out for the last few years, is already showing concern’s about the rising inventories. OPEC has become accustomed to rising prices. The cartel now feels entitled to high prices. It is apparent that with demand growth OPEC must take on a major investment to expand capacity to meet demand. Saudi Arabia for one has ambitious plans to not only expand capacity but invest in building refineries so the can sell refined products as well. And if OPEC is going to stay a step ahead of alternative fuels, they must have spare capacity to keep prices high but relatively stable. With this type of investment on the line, it is unlikely that the cartel can allow prices to fall to high or inventories to rise too high. They know that for now they are the only game in town and they must keep prices high.

And as you talk about oil, it is obvious that you cannot ignore the fact that geo-political events can add even more to the price. We have seen the events around the globe keep a risk premium in the price of oil. Recent events in Nigeria, Russia, Iran and Nigeria have kept the bid premium underneath the market.

Yet if you look beyond the current supply fundamentals, the larger picture shows that for the foreseeable future our demand for oil will continue to grow. And the world will face major challenges to meet then every growing demand.

Obviously the story in the oil market is compelling, but we are seeing similar stories playing out in other markets as well. Similar demand price scenarios are playing out in different commodities across the spectrum. Demand is affecting commodities from foods to metals to fiber. In fact recently it was reported in the Financial Times that Chocolate manufacturer Barry Callebaut has warned of a possible cocoa shortage. The reason is because you might have guessed -- stronger Asian demand. Gold and silver and platinum have surged. Some, including former Fed Chairman Alan Greenspan, said due to terror fears but also due to demand for jewelry in India and China. Also, the demand for steel and metal has been incredible.

The Growth in the US, plus China’s baby steps towards capitalism and a consumer economy, have changed the landscape of the entire commodity complex. China and India's burgeoning middle class now desires goods and services. Cars, TV’s, camera’s, homes...you name it, they want to have those comforts raise a family. In some ways, the Chinese want to live the American dream. These dreams of course are inherent to the nature of man. My thought is that this type of demand is not going to go away overnight. And it is unlikely that supply will overtake demand in the near term. So I believe that the field is wide open, and in some ways the moves remind us of moves in the past. But with the emergence of economies in Asia and the potential upside growth in those economies, the commodity boom is more than likely far from over. And as long as the US economy stays on solid footing, than for futures it continues to offer great opportunity. It is a wonderful field to invest in if you can afford to take the risk. There is high risk involved, yet if you get involved the commodities markets look to be just like a field of dreams.

About Today's Author

Phil Flynn is Vice President, Energy Analyst and General Market Analyst with Alaron Trading Corporation. Phil is one of the world's leading energy market analysts, providing individual investors, professional traders and institutions with up-to-the-minute investment and risk management insight into global petroleum, gasoline and energy markets. Phil's market commentary, fundamental and technical analysis, and long-term forecasts are sought by industry executives, investors and media worldwide.

Most recently, Phil and his energy team were one of the first to predict that global crude oil prices would exceed $30/barrel in the year 2000, a correctly-predicted market milestone which has highlighted the economic scene in the new millennium. Through hundreds of media interviews, Phil Flynn and Alaron Trading have become familiar names in living rooms and boardrooms worldwide. The world's print, broadcast and online media have come to rely on Phil's accurate and animated forecasts and analysis.

Media highlights include: The President of the United States, Bloomberg, ABC, CBS, NBC's "Today Show" and "Nightly News with Tom Brokaw", CNBC, CNN/ CNNfn, FOX's "O'Reilly Factor", PBS's "The Newshour with Jim Lehrer" and "Nightly Business Report", MSNBC's "The News with Brian Williams", Wall Street Journal Report, The Wall Street Journal, Business Week, Investor's Business Daily, The New York Times, The Los Angeles Times, Chicago Tribune, Associated Press, The Toronto Globe & Mail, Houston Chronicle, Futures Magazine and National Public Radio.

Phil's daily market analysis can be viewed at Alaron's website, the world's leading futures Web site. He has been featured on MarketWatch.com and FutureSource.com.

Phil's commitment to and experience in futures trading is documented in two books, The Mind of a Trader (Financial Times/Pitman,1997), and Trading Online (publisher, date), both by Alpesh B. Patel. Phil is a lifelong resident of Illinois. He attended Daley College in Chicago before beginning his career on the trading floor of the Chicago Mercantile Exchange.

 

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