The Forgotten Child of the Current Turmoil – Oil Needs to Regain Its Anchor Point

by Hank Coleman

Cheeseburgers. Whether you eat at McDonald’s or Wendy’s or both occasionally, most Americans have a pretty good idea of how much a cheeseburger costs at a fast food restaurant.  If Burger King came out with a plain cheeseburger that costs $6, most people would balk at paying that high of a price.  It is a lot higher than what is normally considered a prudent price for a plain cheeseburger in the United States.  The price of a burger is anchored near the average price of $1.00.  U.S. consumers want all burgers to be close to that anchor price.  We may be willing to pay a little more for extra features such as bacon, but the standard cheeseburger price is ingrained into the American psyche.  Even Disney understands this phenomenon.  They will gouge you on ticket prices and souvenirs, but they leave you alone with respect to food prices for the most part because they do not want you to leave the park in search of normal food prices.

Stocks.  Behavioral finance has shown that many things are anchored to a certain price, and people have a lot of trouble letting items drift too far from their anchor points.  Stocks are a great example.  Stock analysts give their estimates for a stock they are following, 1 year forecasted stock price and future quarterly earnings.  Most of the time, their forecasts are not too far from last year’s estimate increased at the rate of inflation.  Picking a forecasted price that is in line with several other analysts’ picks cements the anchoring effect and promotes the herd mentality.

Oil.  The price of a barrel of oil has lost its anchor point in recent times, but it has recently returned to hover around $100 a barrel.  Americans and commodity analysts have had trouble recently accessing the accurate value of a barrel of oil when prices continue to rise and fall erratically on the slightest insignificant news tidbit.  The oil futures market has recently seemed to have thrown out the old anchor point of $100 a barrel, but oil has become the forgotten child during today’s current market turmoil.  Oil was once the darling of talk on Wall Street, but the beleaguered commodity has been replaced by failing banks and mortgage bailout talks.  Oil trading happens in the futures market like the Chicago and New York Mercantile Exchanges where contracts are bought and sold.  Conde Nast Portfolio magazine and Goldman Sachs estimate that 42% of the oil trading takes place between traders hopping in and out of positions.  The rest of the trading involves oil companies, oil producers, index funds, etc. who are invested for the long term as part of their company’s hedging strategy.  Commodity index funds now have over $250 billion in assets this year.  To give you some hindsight, the funds had just $13 billion invested in 2003.  There is an absence of bears investing against oil currently, and that is one reason that the price continues to rise.  Crude prices have dropped sharply from record high levels of just above $147 in July as global demand for energy shrank due to the United States led world economic slowdown.  Eventually, oil will settle down from its roller coaster ride and return to its anchor point when bear investors reenter the market.  Just what this economy needs, more bears!

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