Oil, Bubbles, And Gamestop

    For oil traders, the brouhaha surrounding the Gamestop stock price spike is familiar, but also to fans of Charles Dickens, who, in Nicholas Nickleby, described a similar sensation involving the United Metropolitan Improved Hot Muffin and Crumpet Hot Baking and Punctual Delivery Company. The firm was promoted by numerous highly-regarded fellows as promising to elevate the situation of the working class by providing them with hot, nutritious breakfasts. This was a classic case of what is now known as ‘pump and dump,’ wherein speculators talk up a stock’s price and then sell out.

    Of course, Gamestop GME +67.9% is a real company with a real business as opposed to hypothetical crumpets but that is not to say that the recent stock price is warranted by what are known as fundamentals. Ay, there’s the rub, as my broker Hamlet would say. Fundamentals are not always fundamental, as they arguably include a dose of perception and expectations: today’s P/E ratio matters, but is not the only factor entering into the valuation of an equity.

    This can include expectations about the length of the pandemic, economic growth and consumer income in coming months, the extent to which consumers return to in-store shopping and many other factors, none of which is certain. (The possibility that the stock is being manipulated out of anger at hedge funds has been suggested as well.) If the value of any given equity was clearcut there would be a lot of market analysts who would be unemployed.

    There are those economists who insist that markets are always rational and that the price of anything (equities, commodities, real estate, etc.) reflects what buyers are willing to pay. Thus, if the price of oil one week is $50 and the next week $40, neither price is irrational but reflects changes in the perceived value at different times.

    And the price oil has often been described as manipulated, and it certainly has been throughout history: by Rockefeller, the Texas Railroad Commission, the Seven Sisters and, more recently OPEC+. But speculators have frequently been blamed for oil price gyrations, even before the NYMEX began trading oil futures, allowing individual investors (often referred to as ‘doctors and lawyers’) to gamble, I mean, speculate on oil prices.

    During the Oil Crisis, when prices kept soaring after oil returned to the market, the major oil companies complained that speculators were driving the price up. All you needed to be an oil trader, they said, was a table, chair, phone and line of credit. (That last admittedly being a non-trivial requirement.) Since everyone knew prices could only go up, they would buy at any price anticipating a quick sale—and profit—at a higher price. This is also known as momentum trading, a term often used to explain prices that don’t seem justified by fundamentals.

    More recently, the oil price surge in the 2000s was blamed in part on the creation of index funds, which enabled pension funds and others to invest in oil because they were much less risky than futures contracts. But at the same time, there were significant disruptions of oil supply while demand was surging, which certainly could explain much of the price increase. When prices surged in 2008, a few (like me Investing for the oil price collapse - MarketWatch) argued that was a bubble, but many thought the price reflected ‘peak oil,’ a widely believed bit of pathological science many of whose advocates insisted that conventional oil production had permanently peaked in 2005.

    Complaints about irrational or unfair markets are hardly new, and ‘speculators’ have long been blamed by commodity producers for influencing prices. However, in most cases such as with petroleum futures, the market is so broad that it is difficult for any one investor, individual or corporate, to manipulate.

    Except, and it’s a very big except, there are a number of political figures whose decision will affect the near-term price, including Russian President Putin, U.S. President Joe Biden, and Saudi Energy Minister bin Salman, who recently said “I want the guys in the trading floors to be as jumpy as possible. I’m going to make sure whoever gambles on this market will be ouching like hell.”

    But even if today, the Saudi government wants to support the price of oil where it is currently, there is no guarantee that this will not change, for example, if Russian production goes well above quota or U.S. shale production begins to boom again, the Saudis might decide to let prices slide. Minister bin Salman is known for his expertise, but he would probably be first to admit that no amount of expertise can guarantee a forecast of future oil prices.