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There Is No Spoon

April 7, 2008

Business Week has a fascinating article on what’s really going on with oil reserves and gas prices, and why it’s rampant speculation – not growing demand – that’s driving prices through the roof. Money quote:

[In] 2000 approximately $9 billion was invested in oil futures, while today that number has gone up to $250 billion. Now, if any publicly traded company had an additional $241 billion put into its stock in the same period, its stock would rise out of sight too—even if the company was not worth anywhere near that amount of market capitalization.

First it was the dot-com boom and crash. More recently it’s been the precipitous rise and subsequent fall of housing prices, and now this. What the hell is going on with the financial markets? These past ten or so years have been…absurd. They’ve been like an endless succession of bad calls and unlearned lessons.

When you stop and think about it, the pattern is easy to discern. One specific market/industry/commodity somehow emerges as a more profitable investment than others. People invest and in turn make money as the word of this profitability spreads. Everyone proceeds to jump onboard in a bandwagon effect, ignoring the warning signs and assuming they’ve found the goose that lays the golden egg. Then something happens. A few businesses collapse. A few major investors pull out. All of the sudden everyone else is shaken. Maybe the company/product/resource they’ve invested in isn’t worth anywhere near what the thought. They sell and pull their money out, and, because value is largely based on perception, they end up perpetuating a self-fulfilling prophecy.

Granted, there were a lot of flawed fundamentals in the dot-com and real estate booms, but that is EXACTLY WHY they should never have soared to the heights they did. Companies with no business models are bad investments, as are families maxed out on credit to afford everything from their house to their car to their morning cup of Starbucks.

And now oil may be facing its own artificial valuation bubble thanks to the same overspeculation. I can’t pretend to know what will happen. The economics of oil are different from those of tech firms and housing lenders. Can there even be a precipitous drop in oil prices, what with OPEC controlling so much of the world’s production? And if there were to be one, what would it do to the economies of Saudi Arabia, the UAE, Russia, etc?

It’s something to ponder, that’s for sure.

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