Saddam Hussain, Saudi Arabia and higher oil prices

Oil markets are moved by speculators, but they are driven by fundamentals. That important lesson has been learnt by hedge fund and commodity speculators in recent days.

Last month a chart from Dresdner Kleinwort Wasserstein research was published in Dr. Marc Faber's excellent 'The Gloom, Boom & Doom Report'. It showed an enormous amount of speculation in the oil market in advance of the handover of Iraq.

Now the oil market did sink under the weight of this speculation for a brief period last month. But all the signs are that the fundamentals are already back on top, and oil prices are going higher. Indeed, we may be approaching times when $40 a barrel is going to be considered cheap.

Consider the oil market negatives: Militancy continues in Saudi Arabia, and the US has just advised its citizens to consider leaving neighboring Bahrain due to a credible terrorist threat. Even the reappearance of Saddam Hussain's face on the global media appeared to rattle oil markets, and his trial may not actually start until next year.

Meanwhile, Asian economic growth and the US economic recovery continue to put severe pressure on oil supplies that are close to capacity. In short, after 20 years of cheap oil there has not been enough investment in new supply, something which will take some years of high oil prices to correct.

Last week's increase in US interest rates was also too small to dampen global economic growth, with the Washington mafia unwilling to jeopardize economic recovery in a US Presidential Election year.

It will take a combination of much higher US interest rates, which will perhaps soon be necessary to conquer oil-induced inflation, and a consequent slowdown in the world economy to bring oil prices down.

In the meantime, the balance of negatives on the oil price far outweighs the wistful hopes for peace and stability in the Middle East that constitute the main reason for any optimism. And there will need to be quite a substantial shift geo-political policy for that to happen.

So for the time being the gamblers in international oil markets should heed the lessons of last month, and realize that down-on-the-ground, not much has changed.