Oil prices now in the grip of speculators again

To have oil back at $53 a barrel so soon after the $55 price spike last October has caught many commentators unaware. They saw the forces of supply and demand coming back into realignment and 2005 as a time of a gradual reduction in oil prices.

But markets do not work like that! The animal forces of greed and fear that work in capital markets generally lead to an overshooting on the upside and a collapse on the downside. What we are seeing in the oil market is the start of overvaluation in a market where investors around the world pile into black gold.

You only have to look back to the dot-com boom and bust for a recent example of what happens in this kind of market. Basically what begins as a good idea turns into a universal one-way bet and everyone dives in, forcing prices up.

Last week at the well-attended Hedge Funds World 2005 conference in Dubai many funds spoke of their new enthusiasm for commodities in general and oil in particular. Investors, small and large, are also punting on the future of oil. That is why ExxonMobil is the biggest stock by market capitalization in the US right now.

To be fair at this stage oil and both a physical commodity and stock market play still makes a lot of sense. But this weight of money entering the market will have its own impact on oil prices, driving them higher and higher.

Thus oil at $60 and $70 a barrel is quite possible in the near term with even $100 not out of the question. This is then dangerous territory. Oil and this price will begin to cause serious harm to the economies of its customers, and if you forget your customers in business you are doomed!

Indeed, every major period of high oil prices has been followed by a recession in the industrialized world. Why should this one be any different?

Oil prices would then shift into reverse, and overshoot on the downside, which is when Opec would need to make some quick and clever decisions and not mess things up like in 1998.