“A British oil trader in line for a $100m (£60m) bonus is expected to pitch his employer Citigroup into direct conflict with the US treasury after a clampdown on excessive pay by the Obama administration.” 1
How big is the trading profit that allows one trader to qualify for a $100m bonus? How big is the trading position (compounded) which yields a profit big enough to reward one trader with $100m?
The Energy Information Administration advises in their July 2009 Short-Term Energy Outlook that “world oil consumption was down an average of 3.0 million barrels per day (bbl/d) from the fourth quarter of 2008 through the second quarter of 2009.” They further report that US retail sales of electricity in the industrial sector declined by 12% during the first quarter compared to previous year levels. Brent crude was averaging around $45 from Nov 08 to March 09 and then joined the stock exchange rally to trade around $70 at present. The economic dichotomy is the possibility that the oil price increases when demand is falling. Not just any increase but increase by around 56%.
The answer is simple. Speculation. Speculation that the oil price would be higher in the future. This would normally be based on speculation that demand would increase and that would be based on speculation that the economy may be in recovery. What kind of recovery is a speculation driven price increase of 56% anticipating?
I would assert that there is not sufficient evidence of an economic recovery to even claim economic recovery and there is certainly not enough evidence to suggest that such a recovery will explode demand into a market suffering from over capacity to cause a price spike of 56%. Thus this speculation has nothing to do with economic recovery or any expectation of a major improvement in demand.
This speculation has to do with money, piles of it. The “printing press” has been plugged into the trading desks of the “Investment Banks” and they are using it. Clearly having access to unlimited liquidity at near zero interest rates with not nearly enough quality borrowers to lend it to, is no deterrent to channelling the cheap money into other banking activities.
The absolutely obvious destination is anything that would qualify as a store of value. Gold use to be the preferred vehicle but that would invite the anger of the Central Banks. Oil is a very suitable substitute. Liquidity getting out and a market large enough to absorb the flow of liquidity are prerequisites. Sufficient depth and scope in derivatives also help. Stock exchanges are another good destination. Who cares about demand or silly economic theories? We make our own, remember Goldie Locks?
Members of the Pile High Club just plug the liquidity into the Oil market and watch the oil price rise when demand is falling. Soon the crowd realises that the place to be is in oil and a stampede starts. Timing is everything, the Pile High Club exits while the crowd is coming in and guess who then become “investors with a 2-3 year view”?
“He is credited with buying every available oil futures contract in 2003, when they were priced on the basis that crude prices would remain stable. Over the next few years the demand for oil surged and prices soared to more than $150 a barrel, making Hall and Salomon Brothers owner Citigroup hundreds of millions of dollars.” 1
There is doubt about the “surging” demand for oil over the period 2003 to 2006 but then who cares?
“Net revenues in Trading and Principal Investments were $10.78 billion , 93% higher than the second quarter of 2008 and 51% higher than the first quarter of 2009.” 2
How big was the quarterly pile at Goldman Sachs to yield $10.78 billion in trading profits?
Assess this strategy. The liquidity will create demand and will inflate the asset class. It creates a bubble and the bubble collapse when the liquidity driven trades are withdrawn from the asset class. Those in first and out first always win. The members of the Pile High Club. The playing field is tilted at 85 degrees in their favour, they can never lose (not so?). Unless they overstay their welcome, then the trading wipes out the bank overnight. It is also a zero sum game, which means someone will lose. Sometimes the Pile High Club is operating in concert in a market and then there are casualties (just ask Society General about the huge rouge trade which was funded but no-one knew about it).
The Pile High Club will trade the futures, options, in fact all available derivatives and even the physical.
“Morgan Stanley hired a supertanker to store crude oil in the Gulf of Mexico, joining Citigroup Inc. and Royal Dutch Shell Plc in trying to profit from higher prices later in the year, two shipbrokers said.” 3
“"Storage continues to be an option for traders and we see bookings running through at least the end of August, with several of them adding options to extend storage into September," a shipbroker said. U.S. investment bank JPMorgan Chase & Co (JPM.N) has hired a crude supertanker to store gas oil off Malta's coast, a unusual sign traders were looking to take advantage of the weaker crude oil freight rates to store distillates. [ID:nL3650783] The ship would have to be cleaned to hold the refined fuel.
Crude rallied to over $69 a barrel this week, the highest in seven months, as optimism about the global economy outweighed concern about poor fundamentals in oil markets.
Crude oil in floating storage fell in late May to around 90 million barrels from around 100 million barrels as prompt crude prices rose and narrowed the discount to prices further out. [ID:nLS679181] That discount was key to traders storing oil at sea to make profits by selling it later.” 4
The reality is that the access to unlimited liquidity opens the door to a speculative strategy for the Pile High Club which can ignore any economic reality for as long as they can “Cash and Carry”. Thus they can anticipate higher prices when demand is falling. It is like playing poker at a table where bets can be raised without limits and one or a small number of players have pockets deep enough to clear the table every time irrespective of the hand of cards that they hold.
Trade with the money you say, surely you must realise that you can only see the money after it had entered the market and will only realise that it has left after it has gone. Playing at the table with the Pile High Club is dangerous and soon the only players at the table are the members of the Pile High Club. It is then when the accidents happen.
Sarel Oberholster
BCom (Cum Laude), CAIB (SA)
28 July 2009
© Sarel Oberholster
Please email me at ccpt@iafrica.com with any comments. More links and essays can be found on my blog at http://sareloberholster.blogspot.com/ .
1. Phillip Inman, 26 July 2009, Citigroup set to clash with Washington over executive pay, guardian.co.uk; http://www.guardian.co.uk/business/2009/jul/26/citigroup-executive-pay-bonuses
2. 14 July 2009, Press Release, Goldman Sachs.
3. Alaric Nightingale, 19 Jan 2009, Morgan Stanley Hires Supertanker to Store Oil in Gulf (Update2), Bloomberg; http://www.bloomberg.com/apps/news?pid=newsarchive&sid=aIbVHft2R3SE
4. Luke Pachymuthu, 4 Jun 2009, Oil products stored at sea jump to 41 million bbls, Reuters; http://www.reuters.com/article/GCA-Oil/idUSTRE5534JQ20090604
Tuesday, July 28, 2009
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3 comments:
As the biggest bubble in history deflates (still much more to come), the governments around the world are replacing it with government liquidity bubble.
While in the US the liquidity flooding is massively insane, China looks to be the more extreme. At least so far. In a certain sense, I think China is becoming a humongous, gigantic hedge fund, run by the communist government.
The bubble & government schemes -- and cycles -- are analogous to what happened in the past, even centuries ago. The details are different, but the story is the same. In the end, one thing is certain: it's always unsustainable & it brought a multitude of pain & suffering, sometimes a revolt.
In the past, the bubble exploded in different ways. In the present financial system, what will likely cause the end of this government bubble?
In addition to that, do you also explore the ongoing problems in Europe, Sarel? I think people are now focusing too much on the US, while the next big bust may come from somewhere else. Collectively, the EU is the world's largest economy. China looks to be the grounds upon which Asian emerging markets growth & optimism hinges. In reality, I think China is heavily depended on US growth, even more so these days.
I had some readings regarding China & Europe. On China, Michael Pettis discusses the issue very well: http://mpettis.com
As for Europe, I found this interesting paper:
http://www.blackswantrading.com/files/EuroReport.pdf
Regarding Asia (China, in particular) and Europe, do you have any insights, Sarel?
I certainly look forward to your takes & insights. Thanks in advance.
Cheers,
Roger.
Dear Rodger
Good to hear from you again.
I have discussed the channeling of liquidity via the central banks to the banking sector and beyond in War on Savings and a number of other posts on my blog. The convenient conversion of investment banks into Bank Holding entities which gave them access to central bank liquidity is of particular importance. It has opened a direct channel from the Fed to the trading activities of these entities and as such to the trading markets in commodities (oil of importance), derivatives and the stock exchanges. Combining the liquidity of the Fed with derivative leverage poses an extreme danger to orderly markets and has seriously undermined the price formation processes in these markets.
The Chinese authorities channeled their liquidity formation into commodities as stores of value and have stagnated their USD debt portfolios. They have shown a particular preference for base metals. Their ultra stimulatory loose monetary policy found expression in real estate lending, motor vehicle loans and always a favorite, brokerage trading accounts. Thus channeling liquidity (unfunded monetary credits) into real estate, the automobile sector and the stock exchange.
We note that commodity hoarding and commodity speculation are combined with an open liquidity channel into stock exchanges to create yet again asset bubbles through the use of “money from thin air”.
In the end it is always supply and demand that breaks up the party and each new cycle is shorter. Thus at some stage China would not want to increase its “strategic commodity reserves” for its demand would not justify it. The over stimulation of capacity during the hoarding period will fall away. The lack of consumption demand would re-assert itself and the malinvestments will initiate the deflation adjustment as discussed in War on Savings. The lack of new brokerage account lending would dry up the stock exchange stimulation and pop the asset bubble. I expect these events to be in the near future given the global economic conditions. I do not see any gains for China in this game.
I believe that the EU may be more resilient than the expectation of the Black Swan Trading report. It is good to acknowledge the trends that they identify but I believe that the EU will find ways of dealing with these problems without having members leaving the EU. I would also expect particularly that straying EU members will continue to try and gain unfair advantage. It is in the nature of the EU relationships that these will be harmonized in political processes. I do not foresee a collapse of the EU or the euro from a structural point of view.
I do agree that the euro and the EU may be in for some heavy weather given the problems of the PIGS, the banking exposures to Eastern Europe, some reckless current account and trade deficits and the almost general cheating on budget deficits.
The USD as a store of value and with full knowledge of the activities of the FED is still a better bet than most other currencies. Compare for instance the rhetoric of Russia while they are creating new money at around 50%pa. Hardly a platform from which to throw stones. China as a total control economy with an export bias and weak currency policy must, as did Japan, always over stimulate money creation in Yuan to pay exporters in local currency for their export dollars. Same model as Japan and it is almost inevitable that they would follow a similar economic outcome.
Comment continued;
This brings us to deflation, inflation, hyperinflation and its relationships with currencies. I am not of the opinion that the UDS is in serious danger of severe weakening against challenger currencies or in danger of being replaced as reserve currency of the world. Not because of a misplaced faith in the FED but because of a faith in the ability of other central banks in outperforming the Fed in creating local currency growth from thin air in a greater proportion relative to their economies than the Fed’s ability to do the same with the USD. This view contributes to my expectation that the USA will remain stuck in the deflation model. Those economies where loose monetary policies and stimulatory fiscal policies are allowed to develop into a sovereign debt crisis will experience a currency collapse and with it hyperinflation events.
I find it very difficult to envisage a collapse of the UDS against any other currency in the world today. A hyperinflationary event without a sovereign debt default and an exchange rate currency collapse is almost impossible to envisage.
I would not like to pinpoint any particular country or currency as we are looking at a global economy where severe distortions are everywhere and a trigger for crisis can originate from a small Latvia to a UK, China or USA.
The global economy needs to restore some semblance of sustainable economic equilibrium and harmony without structurally distorting unfunded monetary credits (money from thin air), unsustainable levels of public or private debt and must practice conservative fiscal policies. I expect that we will stumble from one crisis to the next until we arrive at that point.
Kind regards,
Sarel Oberholster
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