Weekend Dec 31 2016
So, how does one explain the conundrum that price can rally amidst the largest surplus ever?
The simple answer is the economic financial dichotomy of different thinking about different commodities.
Economic Gods
An avocado is an economic good. People will only pay so much for their guacamole. They jump off the HEB aisle at 2 for $3.00, large HAAS. But if the price were 1.50 each times say 12, an avocado would cost $18. And at that price, they would spoil on the aisle. By definition, an economic good is one which responds to changed in supply and demand, the classic macro economic model.
Financial Goods
This is not however the case for financial goods. A financial good is one whose price is NOT determined by supply and demand. Rather the social mood or belief system surrounding the good determines the price. Examples in include the dot.com mania which IPOs carried hefty prices while the underlying companies went thru cash burn with no earnings.
Bennie Babies and certain dog and cat breeds also display this sort of irrational pricing.
Amazon has only recently begun to make money but carried a high stock price for years while losing money, so much for the discounted earnings approach to stock pricing. Ditto, Tesla.
Now to the oil price. Oil prices bottomed at $12 in 1998-99 when I left Odessa, Tx. Eight years later the skyrocketed to $144, a gain of 12x. Our avocado never did this (nor did egggs, cheese, or t bone steaks). The difference is the perception that prices will continue to move higher. In short social mood is pricing the item on expectations, not on VALUE! The same is true for an option on a stock or commodity There is the intrinsic value, if the option is in the money, say a $45 call on Flossers which is trading at $498, intrinsic value is $4. But the call will likely trade for say $6, $2 is the speculative value based on future expectations.
Crude oil either trades an financial multiple above its cost or production, which was $110. Or when mood reverses it trades at at a discount to the cost of production, at $25 oil probably cost $45 to produce.
If we want to follow the social mood ofoil, I submit we should teach thevolume of trading infuser and option contracts on the price of oil AS the volume expands with prices, social mood is moving price higher. And as with an economic good, volume will drive price higher. Oil is probably trading just over the cost of production now, which is to be expected after a massive fall, correction wiping out marginal producers via bankruptcy, and then a recovery as strong hands assume the assets of those wiped out.
Robert Precther coined these ideas, it snow my research interest, and here is his explanation. I spoke at the Socionomic Conference in Atlanta in 2016 and then a month later at the Warwick University Conference on Mood in Coventry, England.
http://www.socionomics.net/socionomics-explained/
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