Outtake from the bigger post below , will comment as a reply....
"Hedge funds and other money managers still have net long positions in WTI-linked futures and options amounting to 203 million barrels of oil, and another 67 million barrels of Brent-linked derivatives. It is unlikely they would run such a big position if they expected prices to be flat or increase no more than 10 percent over the coming 12-24 months.
The hedge fund community is positioning itself to capture significant upside tail risk in oil prices, and much of the commentary from the banks suggests they also see risks firmly tilted towards the upside. "
From: CommanderCricket 7/14/2011 9:18:13 AM
of 154072
Time for bulls to choose between economy and oil: Kemp
(John Kemp is a Reuters market analyst. The views expressed are his own)
research.tdwaterhouse.ca
By John Kemp
LONDON, July 14 (Reuters) - There is a fundamental contradiction at the heart of the Federal Reserve's economic forecasts and the investment strategies recommended by oil and commodity analysts.
Fed Chairman Ben Bernanke pins his hope for faster growth on the levelling out of oil and other commodity prices. But most banks and hedge funds are predicting continued growth will drive commodity prices much higher.
They cannot both be right.
Presenting the Fed's latest semi-annual report, Bernanke argued "the recent weaker-than-expected economic performance appears to have been the result of several factors that are likely to be temporary. Notably, the run-up in prices of energy, especially gasoline, and food has reduced consumer purchasing power".
"Looking forward, however, the apparent stabilisation in the prices of oil and other commodities should ease the pressure on household budgets".
In contrast, bullish forecasters at Goldman Sachs, Barclays Capital and other leading commodity banks are instead arguing faster growth in the advanced economies and continued strong gains in emerging markets will lead to higher commodity prices.
It is just about possible to square these contradictory views. In a goldilocks scenario there would be a modest acceleration in global growth, a slight tightening of oil supply-demand balances, and only modest upward pressure on prices.
The global economy grows fast enough to edge prices higher but not so fast it results in a price spike that would throw the recovery off track. There is a careful rebalancing in the source of growth from emerging markets to the advanced economies.
It is possible but the odds appeared stacked against it. Much more likely is that the economy speeds up, triggering a sharp non-linear increase in oil and other commodity prices, or the continuing burden of high food and fuel costs leads to a continued period of subdued growth in the advanced economies and more moderate growth in the industrialising ones.
RHETORIC AND REALITY
As former president Bill Clinton might have noted, much of the debate about oil prices and the economy turns on the meaning of the word "stabilisation".
Bernanke and his closest colleagues seem to accept oil and other commodity prices may rise further as the expansion matures. But they believe any gains will be modest, certainly much smaller than experienced over the last 24 months, and the economy could absorb gradual increases. In this view, rates of change are more important than price levels.
In fact, despite the rhetorical differences, Bernanke's position is not far from the official position of the commodity banks. While their forecasters' rhetoric is often strongly bullish, the actual predictions are far less so .
In its latest forecast, Barclays Capital predicts Brent will average $112 per barrel in 2011, scarcely different from the $111.60 average for the year so far -- implying it thinks prices will oscillate around current levels for the rest of the year. The average forecast for 2012 is only $115, rising to $125 in 2013, which suggests only a very modest tightening of oil markets over the next two years ("Energy Flash: Oil Market Update" July 5).
Goldman is a little more bullish, predicting Brent prices could hit $130 within 12 months, though that is a point estimate not an average, and it is only 10 percent above the current level ("Commodity Watch" July 7).
BETTING ON A SPIKE
Publicly, the Fed chairman and the banks agree prices are likely to stabilise within +/- 10 percent of their current level. But that would be a surprising degree of stability in a market that has experienced wild annual swings. It would be the smallest annual change since 2007 and the third smallest change since 1998 (http://graphics.thomsonreuters.com/ce/BRENT-CHG1.pdf).
It is not what most market participants expect. Implied volatilities suggest a range of expectations of $50 or more at the twelve-month forecasting horizon for WTI, according to an analysis compiled by the Energy Information Administration, and presumably they expect a roughly similar range for Brent (http://www.eia.gov/steo/uncertainty.html).
High open interest in oil-linked futures and options contracts suggests an unusually wide range of views at present, with at least some market participants expecting prices to rise far higher than this.
Hedge funds and other money managers still have net long positions in WTI-linked futures and options amounting to 203 million barrels of oil, and another 67 million barrels of Brent-linked derivatives. It is unlikely they would run such a big position if they expected prices to be flat or increase no more than 10 percent over the coming 12-24 months.
The hedge fund community is positioning itself to capture significant upside tail risk in oil prices, and much of the commentary from the banks suggests they also see risks firmly tilted towards the upside. The relatively conservative published forecasts are no more than a minimum baseline -- with a strong possibility that they will be exceeded.
Behind the conservative public numbers, there seem to be a set of "shadow forecasts" which are far more bullish and which are captured in the strongly optimistic commentary rather than the official price forecasts. It is these shadow forecasts that encourage hedge funds and other investors to run substantial long positions.
But the shadow forecasts are far from consistent with Bernanke's hopes for price stabilisation. If prices did surge in the way many hedge funds and others with real money at stake clearly think is at least somewhat likely, the Fed's careful optimism about a gradual strengthening of the recovery could turn out to be far too hopeful.
TIME TO CHOOSE
The major investment banks have institutional reasons to be bullish on all or most of the product lines in which they make markets. But it is harder for investors to be bullish about both oil prices and the prospects for recovery in the United States and the rest of the world.
Higher oil and food prices would significantly increase the already heavy burden on struggling households in North America and parts of Western Europe.
While oil analysts argue over the extent of demand destruction as a result of the surge in prices since August 2010, the economic impact is unambiguous. Bernanke has cited rising gasoline prices as the number one reason for the U.S. economy's "soft patch" in Q2, and a similar analysis is shared by senior officials at the Bank of England.
There is no doubt a further rise to $130, $140 or even $150 would prolong and perhaps deepen the slowdown in the advanced economies.
Bullish forecasts about both oil and growth therefore rest on the hope emerging markets would remain immune, as a result of their strong underlying growth momentum as well as price controls and subsidies that blunt the impact of rising global oil prices on local consumers.
This also seems too optimistic. If anything, the impact of rising food and fuel prices on social, economic and political stability in these countries is greater. Rising oil and food prices have already sparked a sharp increase in inflation and begun to draw a response from local central banks. If oil prices rise to $130 or more, the inflation problem will only worsen.
Susidies and price controls will become prohibitively expensive and more difficult to maintain the higher prices rise.
So while it is possible to construct a soft landing scenario, it is hard to make it the central projection with any degree of confidence. Investors may have to choose between bullishness on oil and bullishness on the economy. It will be difficult to have both.
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