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Dian L. Chu

Dian L. Chu

Dian L. Chu, is a market analyst at EconMatters.EconMatters  is made up of a team of financial and market analysts who research, analyze, and write…

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Pinched By $4 Gasoline? Blame The Big Banks

Yes, that's right!  The same Big Banks that taxpayers bailed out during the financial crisis are now jacking up oil and gasoline prices (Fig. 1), thus making consumers pay yet once again at the gas pump.  Don`t buy into the hype fed to the media by the Big Banks about impending global oil supply crisis due to the unrest in the MENA (Middle East and North Africa) region.

Regular Gasoline Prices

It All Started With Jackson Hole….

This run-up in oil prices started with Fed Chairman Bernanke`s Jackson Hole speech where the big banks realized they were going to get a bunch more juice in the form of POMO operations by the Federal Reserve to play around in markets with.

And what did the large financial institutions do with this newly created juice? Instead of allocating the almost zero percent money they are all borrowing to productive activities such as lending loans to small businesses which will create jobs and stimulate the economy, the big banks have decided that since the fed is electronically printing money and providing extra liquidity/juice for financial markets that this is inflationary and devalues the dollar.

All Fed Juice Leads to Commodities

And just to make things worse, the big banks have decided to take their cheap capital they borrow at basically zero percent , and invest into commodities, i.e., agricultural futures like Wheat, Corn, and Soybeans, energy futures like Oil and Gasoline (Fig. 2), and industrial and precious metals like Copper, Gold and Silver.

Gasoline Futures Price

The unique aspect is that loose monetary policy isn`t problematic at face value when you are trying to stimulate growth, it is what the Big Banks are utilizing this cheap capital for that becomes problematic from an inflation standpoint. The very problem that the Banks are worried about in regards to inflation, they are in fact responsible for creating through self-fulfilling investment practices with regard to this cheap capital at their disposal.

Long Commodities, Short Dollar - Adding Inflation

But it gets worse because at the same time they also short the US Dollar, and going long the commodity currencies like the Canadian and Australian Dollar, which further exacerbates the slide in the US Dollar (Fig. 3), reinforcing the entire trade that they need to buy more commodities as an inflation hedge, further juicing up commodities like oil and gasoline.

Dollar Index Spot

Inflation Up, Purchasing Power Down

The consumer is hurt in two ways. First is that higher prices eat into their monthly budget with a higher percentage of their disposable income needed for purchasing items like milk, eggs, bread, and gasoline. Secondly, because the Dollar is losing its store of value, the consumer is losing their purchasing power, i.e., what a dollar is worth in relative terms around the world, and what it can buy. In other words, it is like getting a pay cut at work from your company, the amount hasn`t changed, but what goods that amount will be able to buy is less.

Consumers Getting Double Stiffed

The Big Banks like JPMorgan Chase, Goldman Sachs, Morgan Stanley, HSBC, UBS, and BOA-Merrill Lynch are some of the largest energy traders in the world. They all derive considerable trading revenue from the markets each quarter. So when you hear that Goldman Sachs, or BOA didn`t have a single losing trading day for a given quarter, these banks are taking a lot of money out of the market, and much of their hefty trading profits are generated from commodities like food and energy.

And guess who is footing the bill for these trading profits? Yes, the US consumer, the very same US consumer who bailed them out during the financial crisis. Talk about getting short shrifted twice. (I cleaned up the last sentence, but you get the gist.)

2008 Oil Bubble Redux

Currently, there are no supply shortages in the oil market, but what you have is a bunch of speculators going wild pushing up energy prices hyping the Middle East, Peak Oil, The Nigeria Card (remember in 2008 where every little Nigerian pipeline was under attack every day during that run-up, and all the sudden Nigerian pipeline attacks were inconsequential for two years—that`s the Nigerian Card-bring it out when traders are in Trend Trading Nirvana.)

What we have here is a 2008 redux. The Brent contract on the ICE exchange is being used to engineer prices up, as it is an unregulated exchange with no real transparency on position limits by the Big Banks. The Big Banks are also piling a bunch of money into commodity related ETF`s and mutual funds, which in turn have to buy exposure to the futures market in all these commodities. Add in the hedge funds, pension funds, money managers, and retail traders, and voila! you have these bubbles created which have no relation to the underlying fundamentals.

Trend Trading Hyper Leverage

It all comes down to fund flows, capital going into the commodity trade because it is going up, further adding fuel to fire that this is the place to be-- Welcome to the self-reinforcing cycle of Trend Trading.

However, it gets even worse, because we have one-sided markets with no substantial pullbacks which normal healthy markets have. The Big Banks are able to add to their original positions with the profits they have locked in with stops that are already hugely profitable. The Big Banks are then buying additional futures contracts, pushing these same commodities up further, until eventually the bubble bursts like 2008, when everyone runs for the exits at the same time.

The effect is that by adding to original positions via locked in profits, the Big Banks have added even more liquidity/juice to the market – a form of hyper leverage without real risk. This results in the consumer paying more at the pump, not because there is less supply of oil in the market, but largely because of a trading technique that artificially inflates prices by adding more juice to the equation.

Crude Oil – An 'Engineered' Market

I know we had a recession, but Crude Oil went from $143 dollars a barrel to $33 in six months. Now, you don`t think demand dropped off that much, do you? It didn`t, even when a consumer lost their job , which at most we went from a 5% unemployment level to slightly above 10%--did this 5% completely stop consuming fuel? I know this is an oversimplification; however you can follow where I am going with this line of reasoning-- Crude Oil should never have been $143 a barrel in the first place!

It was stage-managed to those levels the last time by the Big Banks like Goldman Sachs. Remember the infamous “$200 Oil Call” by the Goldman analyst – do you truly believe that happened by accident? It most likely served a purpose for Goldman Sachs at the time, to help ‘market’ the price of Crude Oil.

Banks Long Oil...Gee, You Think?

You now have Nomura Securities with their $220 Oil Call, and J.P. Morgan pumping out weekly analysts forecasts regarding Crude Oil targets of $130 for the second quarter. Why make these price forecasts available to the media and the public if they aren`t used for a purpose? Wouldn`t they want to keep these reserved for their paying, private clients? Gee, I wonder if they are positioned long in the Oil Market?

You guessed it. The same Banks that won`t give you a loan, or a credit card because your credit score isn`t perfect is making your financial condition even worse by pushing up the price of Oil, Food and Gasoline when there are no real supply shortages in the market. 

The overall trend of a decline in new consumer credit line approval has also been noted by the industry monitoring service at credit-land, whereas in early 2008 a FICO score of 625 was still acceptable for approval, today you would need a score of 725 or more to qualify for the same offers.

So, what is taking place in the market are traders hitting revenue goals by trading commodities, using the QE2 liquidity, in order to maximize their bonuses.

Fed, The Enabler

This is not all the Big Banks fault, as just like in 2005-2007, regulations were eased to let them all lever up over 40 times base capital. Well, Chairman Bernanke and the Fed`s extremely loose monetary policies have enabled the banks to profit enormously from trading behavior and investment choices which inevitably have lead to the creation of another inflationary bubble. We still have a long way to go in recovering from the last Fed fueled bubble regarding the Housing Industry from the Alan Greenspan era of overly loose monetary policy.

Higher Margin Requirements - Not The Solution 

In addition, the CFTC was supposed to come up with position limits for the Big Banks over 3 months ago, but even the limits they were considering were not going to do any good. The CME has raised margin requirements on all the commodities, but this actually makes things worse because it squeezes out more of the smaller speculators. It concentrates more of the contract from a percentage standpoint with the Big Banks who have access to all the capital they could ever need at zero percent interest.

If you raise margins for the Big Banks, they just go borrow more money to cover the raised requirements, but they never have to reduce positions like the smaller players. This makes for less of a diverse market. Therefore, raising margins isn`t the answer either. In other word, don`t expect any relief from the CFTC or the exchanges--they really are powerless to reduce this type of speculative fervor.

Two Ways To Tame Big Bank Cats

There really are only two options:


1)  Bernanke has to immediately change his tone, and become much more hawkish regarding inflation, and he needs to do this immediately, as in, Monday morning. He needs to say something to the effect: “Due to rapidly building food and energy cost pressures, the fed needs to seriously discuss the idea of cutting short QE2 at our next monetary policy meeting on the 27th of April”.

That`s literally all Bernanke would have to say, not that they are going to cut QE2 short, just discuss the idea, and that you are worried about rising inflationary pressures in the economy exemplified by the unprecedented spike in gasoline prices. This would send the right message to the speculators, and curb much of the speculative fervor. All commodities would instantly sell off. For example, Oil would drop by $3.50 in an hour, and the RBOB contract would drop 18 cents.

This is how you can even maintain all the benefits of a relatively loose monetary policy without all of the acute negative consequences of unchecked speculation, which we are experiencing right now in commodities. It’s a one sided trade, that is crowded, unnatural, and bad for markets and consumers alike.

2)  The second option is more micro managing an individual commodity. Let`s take Oil for example. President Obama could make a statement on Monday morning stating the following: “I have decided to open up the Strategic Petroleum Reserves to the market, not because there are any supply shortages in Crude Oil, far from it, actually, but we want to target the excessive speculation that we believe is occurring right now in the Oil market”.

Again that`s all it would take and Crude Oil would be down $3.50 and gasoline would drop as well. You do not even need to sell any Oil from the reserves, it actually isn`t needed, but the important part is the message that you are sending to markets, “this is not a riskless, one way trade.”

Speculation Not All Bad, But...

Speculation isn`t always bad, in fact, it often serves many valid purposes within markets. But excessive speculation to the point where markets diverge considerably from the underlying fundamentals is never a good thing. And it is important for those in positions of authority to manage such markets appropriately through legislative regulation, monetary policy, or simply managing market participants’ expectations by sending the right types of messages to markets.

Fed's Punchbowl Ends Here & Now

However, our policy makers so far have mismanaged the message being sent to Wall Street. It is something along the lines of “Get drunk at the Fed inspired liquidity punchbowl, and don`t worry about the mess you make”. The message the Federal Reserve should be sending is, “Make sure you don`t drink too much at the liquidity punchbowl, or we will take it away”.

The reasoning here is that it is always much easier to prevent the mess in the first place, than to try and clean it up afterwards. We have reached the point where the Fed needs to take the punchbowl away!

By. Dian L. Chu

Dian L. Chu is a market analyst, founder and editor of EconMatters.

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  • Anonymous on April 07 2011 said:
    I call BS. It is a cop out to blame everything on the banks. They're greedy, they're not all that smart, but at least they are smart enough to hedge on an energy supply that is increasingly going tight on supply."the big banks have decided to take their cheap capital they borrow at basically zero percent , and invest into commodities..."Isn't this what everyone and their mother have been advising to do? It's no suprise that the banks would eventually get on board to in order to protect their assets.Stop looking for a conspiracy in the white noise. The real facts are
  • Anonymous on April 07 2011 said:
    continued...The real facts are that oil is the backbone of the economy and we are using ever more amounts of the limited supply. Infinite growth was a myth perpetuated by the establishment and its economists. Only now are you seeing less pundits discussing "growing the economy to health". The world is too populated and we are well past the carrying capacity of the planet. But it sure would be easier to understand if we just blamed everything on one group of individuals.
  • Anonymous on April 07 2011 said:
    Yes, we have oil......but can't produce enough of it at reasonable price (EROEI). That is what peak oil means. It doesn't mean we are 'running out'. It just means the world can not produce enough to keep up with demand and indeed the world has reached 'peak' production. This is one reason the world economy is on the rocks. The world needs ever more inexpensive oil to continue growth and to service debt. That is not happening and we are seeing the unhappy results. The world burns through better than 33 Billion brls of oil a year. So a find of 20 billions brls, although seeming large, really is less than a year's supply and that is assuming that all of the 20 bil brls is actually recoverable.
  • Anonymous on April 08 2011 said:
    No Dian, it isnt the Big Banks that have caused the trouble. It is the Big Fools - the fools who threatened Qaddafi instead of talking with him.And you are missing the financial economics here. When the fools went into action and the financial people saw what was going to happen, they went long. You would have done the same thing if you were in their place.
  • Anonymous on April 08 2011 said:
    I'm sorry but the authior is a journalist, not an analyst. Analysts do not go around saying 'Yes, that's right!' and 'Gee, you think?'. This is journalese for idiots. I simply don't trust what she is saying, however right it might sound. Can we please have a professional analyst to comment in a profgessionally analytical fashion...?
  • Anonymous on April 08 2011 said:
    In regards to 'Peak Oil', here is a news flash:US crude supplies have risen in 10 of the past 11 weeks, reached 357.7mm bbl, gasoline demand down 1.2% yoy in the week ending April 1. We don't even know how much is sitting on the Brent side as there's no regular inventory report. So, here and now--in the next 30 days-- 'Peak Oil' is unlikley to materialize, not to mention China is raising fuel prices, while demand destruction is starting to manifest. Yet crude prices (for May delivery) are still moving up. Although many have concluded that trading activities have very little effect on oil market, but after you eliminate the demand and supply factors, whatever remains, however improbable, must be the answer. In addition, another News Flash:An anlayst is a person who's able to synthesize confluence of info. into conclusion(s) and informed opinion(s), writing style notwithstanding.
  • Anonymous on April 09 2011 said:
    Peak oil is not the issue - or an issue - Dian. The issue is the price of oil! I putlished a 'preliminary' article called OPEC's stragegy a while back, and I have been giving this a lot of thought lately, and the business about the increase in the US oil supply is completely and totally uninteresting and irrelevant.I think that we should face the facts here. The decision to go to war with Colonel Gaddafi instead of talking with him was nutty, and as we may already be finding out, nutty on the plane of macroeconomics.
  • Anonymous on April 09 2011 said:
    As a middle-aged European I cannot abide mixing formal informational writing with casual writing. My generation was brought up to separate the two styles very firmly. To my mind therefore an analyst is someone who is able to show by giving accurate and reliable informartion based on experiernce and professiional competence what the trend is, and is likely to become, AND by giving this information to their readerrship in such a way as to demonstrate by their writinfg style the maturity of their thought process and their respect for the maturity of the readership, and by not mixing casual with more formal.Therefore 'Yes, that's right. and 'Gee, you think' among other expressions of that sort do not constitute 'maturity of writing' or respect for maturity in the readership, in my opinion. I therefore cannot consuider the author's information to be reliable.I will undoubtedly get shot down in flames for saying that, but I'm sorry, that is my way.
  • Anonymous on April 10 2011 said:
    Dian's work is OK with me Philip, and I cite it on several occasions in my new textbook. As for the expression 'Gee, you think', that sounds my oldest daughter or her children,when they are explaining something about computers to me, only it goes like this 'Gee, you think, fool.'
  • Anonymous on April 19 2011 said:
    The uber rich use OIL as their GOLD. You do not see wars about GOLD. It's a method of CONTROL.YOu think there is no CLASS WAR going on? Well, there is and they are running far ahead of the people on the bottom cuz they have a PLAN.

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