Tuesday, April 12, 2011

Monetary Inflation vs. Price Inflation

Rising Oil prices are NOT the "cause" of Inflation, they are a "symptom" of  Monetary Inflation.

The term "inflation" originally referred to increases in the amount of money in circulation, and some economists still use the word in this way. However, most economists today use the term "inflation" to refer to a rise in the price level. An increase in the money supply may be called monetary inflation, to distinguish it from rising prices, which may also for clarity be called 'price inflation'.  Economists generally agree that in the long run, inflation is caused by increases in the money supply. However, in the short and medium term, inflation is largely dependent on supply and demand pressures in the economy.
 -Federal Reserve Board's semiannual Monetary Policy Report to the CongressRoundtableIntroductory statement by Jean-Claude Trichet on July 1, 2004

With regards to Oil prices, the financial media is relentlessly pounding their Inflation drums because of the present rise in the "price" of Oil.  They are completely ignoring the supply/demand fundamentals of Oil with respect to price.  This begs the question, what is driving Oil prices higher and feeding Inflation fears?

The media itself is confused on what is driving Oil prices higher.  Just this morning the following two headlines appeared within hours of each other on Yahoo Finance:

Oil extends losses, high prices may hurt demand
On Tuesday April 12, 2011, 2:38 am EDT

Oil near $110 as 2011 crude demand seen rising
Pablo Gorondi, Associated Press, On Tuesday April 12, 2011, 7:54 am EDT

What the financial media SHOULD BE focusing on is the SUPPLY of Oil.  Sure, we get countless reports daily about the unrest in the Middle-East, and how this will effect supplies to an Oil thirsty World.  Absent Libya, there has been very little disruption to World Oil supplies to date because of Mid-East or North African political turmoil.  In fact, at present, the World is literally flooded with Oil.  The US is literally drowning in it, and facing a virtual Oil tsunami as the futures markets head into the May delivery period.  Oil speculators have once again hoodwinked the CFTC and allowed Big Oil to steal billions from energy users via overpriced petroleum products.  

In a revealing piece of journalism at Phil's Stock World, a strong light has been cast upon the Oil speculators over at the NYMEX [The New York Mercantile Exchange...cousin to the CRIMEX].  These "speculators" have driven the price of Oil, literally, to undeliverable heights.  There is now more Oil in the pipeline to the US, than there is room to store it.  Read on:
NYMEX futures expire on April 19th and delivery must be accepted at Cushing, OK, in May for any May contracts still open on the 20th of April.  There is nothing that the conga-line of tankers between here and OPEC would like to do more than unload an extra 277 Million barrels of crude at $112.79 per barrel (Friday’s close on open contracts and price) but, unfortunately, as I mentioned last week, Cushing, OK is already packed to the gills with oil and can only handle 45M barrels if it started out empty so it is, very simply, physically impossible for those barrels to be delivered.  This did not, however,  stop 287M barrels worth of May contracts from trading on Friday and GAINING $2.49 on the day.

Who is buying 287,494 contracts (1,000 barrels per contract) for May delivery that can’t possibly be delivered for $2.49 more than they were priced the day before? These are the kind of questions that you would think regulators would be asking – if we had any. In fact, the last contract actually purchased in June was at $104.03 and the last contract purchased in July was at $91 and the last contract purchased in August was $95.70. Why? Because the price you pay at the pump is set by the FRONT-month contract only and it’s not worth manipulating the forward contracts until they become the front month. Again – if only there were regulators to look into these things…

The great thing about the NYMEX is that the traders don’t have to take delivery on their contracts, they can simply pay to roll them over to the next settlement price, even if no one is actually buying the barrels. That’s how we have developed a massive glut of 677 Million barrels worth of contracts in the front four months on the NYMEX and, come rollover day – that will be the amount of barrels "on order" for the front 3 months unless a lot barrels get dumped at market prices fast.

Keep in mind that the entire United States uses "just" 18M barrels of oil a day so 677M barrels is a 37-day supply of oil but we also make 9M barrels of our own oil and import "just" 9Mbd, and 5M barrels of that is from Canada and Mexico who, last I heard, aren’t even having revolutions. So, ignoring North Sea oil Brazil and Venezuela and lumping Africa in with OPEC, we are importing 3Mbd from unreliable sources and there is a 225-day supply under contract for delivery at the current price or cheaper plus we have a Strategic Petroleum Reserve that holds another 727 Million barrels (full) plus 370M barrels of commercial storage in the US (also full) which is another 365.6 days of marginal oil already here in storage in addition to the 225 days under contract for delivery.

Wow, that is some long-term supply disruption that they are pricing in, isn’t it? It’s a scam folks, it’s nothing but a huge scam and it’s destroying the US economy as well as the entire global economy but no one complains because they are "only" stealing about $1.50 per gallon from each individual person in the industrialized world.

It’s the top 0.01% robbing the next 39.99% – the bottom 60% can’t afford cars anyway (they just starve quietly to death as food prices climb on fuel costs). If someone breaks into your car and steals a $500 stereo, you go to the police but if someone charges you an extra $30 every time you fill up your tank 50 times a year ($1,500) you shut up and pay your bill. Great system, right?


These statistics would seem to indicate that a correction in Oil prices may be at hand.  I have noted recently that a fall in oil prices would bring down Silver prices.  It would appear that this is beginning to now occur. 

Oil was last to the party as the commodity sector soared over the past several months.  One could make the case that it was the speculation in the Oil markets because of the "revolutions" in the Middle-East and North Africa that pushed the CRB over the top and into new All-time highs recently.

Interestingly, it has been the falling US Dollar that has been the primary driver of the explosion in the prices of commodities the past six months.  Gains in the CRB had been modest until revolution sparked in Egypt in late January, and spread across the region driving Oil prices higher amid speculation of supply disruptions.

Oil supply speculation, coupled with a continuously falling US Dollar, has placed enormous pressure on the "price" of Oil globally.  Supply statistics, however, do NOT support Oil prices at such lofty levels as we have seen of late, but the falling US Dollar does.

Monetary Inflation is at the root of rising prices globally.  With the US Dollar as the World's Reserve Currency, and commodities priced in US Dollar's, Inflation fears rest more with the falling value of the US Dollar than with "supply speculation" in various commodity markets.  Legitimate "supply disruptions" in any commodity market will only exacerbate the rising prices already caused by Monetary Inflation.  Speculation in the futures markets of commodities based solely on "possible" supply disruptions will act to distort prices towards unsustainable levels in the near-term.  That being said, we must consider the possibility that a possible peak here in Oil prices may signal a "near-term" top in commodities AND Silver and Gold.  Should the US Dollar find a near-term bottom here near 75 on the USDX, this near-term top would be confirmed and a corrective/consolidation phase may appear and slow the rise in these markets for a short period of time.

Silver's rise near $42 early yesterday did not shock me, but it was somewhat surprising.  That Silver has risen this high should surprise no one.  The potential was there when it broke from it's Bullish Flag formation on March 21.  That the rise from that breakout at $35.50 was relentless and mostly unopposed was surprising.

At it's peak of $41.93, Silver was 59% above its 200 day moving average resting at $26.37.  That Silver has moved this far above it's 200 day moving average is not so much shocking as it is alarming.  Since it's low in July of 2010, Silver has clearly risen higher with the price of Oil...it's 8% move higher just last week coinciding with an explosion in Oil prices as the Oil futures markets went ballistic:

It is evident then,based on the chart above, that should Oil prices correct here, Silver prices most likely will as well.  This Oil Silver relationship has played a big part in my caution with regards to Silver prices recently.  But Silver's 59% rise above it's 200-Day moving average has screamed caution.  Anytime Silver gets to be over 40% above it's 200-Day moving average, the Silver market is getting far too ahead of itself.  A correction in prices in the "near-term" become inevitable.  Are we there now?  Possibly.  Will Silver undergo a major correction here.  Possibly, but unlikely.  A major correction would be a move down in excess of 30% from here.  A move that big would take Silver below $30 an ounce.  That just doesn't seem likely...but this is the Silver market, and ANYTHING is possible.

Silver opened 2011 46% above it's 200-Day moving average, and corrected by 15.5%.  This correction dropped Silver below it's 50-day moving average to only 18% above it's 200-Day moving average.  A similar correction in Silver today would only drop prices to $35.34, and not even reach it's 50-Day moving average.  A 15.5% correction would only take Silver to within 33% of it 200-Day moving average.  The fact is, we are not even sure yet that Silver is on the verge of correcting, it has yet to break below it's near-term uptrend line now at $39.50 .  But know this, whenever Silver has corrected in the past from extreme valuations above it's 200-Day moving average, it has been a decent that is fast and furious once it begins.  On average, the first week of these corrections in Silver have seen loses of 11%.  For more on the dynamics of corrections in Silver form extreme valuations relative to it's 200-Day moving average please read this essay Silver Toppings 2 by Adam Hamilton.

As I reach for the send button, Gold has just bounced off of near-term support at $1445 in a retest of it's recent breakout from a long consolidation.  Impressive, and expected.  Coincidentally Brent Crude bounced off $120 support and it's rising near-term trend line at same.  The convictions of the Bulls, and the speculators are about to being tested...

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