5
Jan

Feeling the Pain of Volatility - The Irrational Fear of Popping The Oil Bubble $VIX $XOIL

I am a patient Wife, but I must admit that I had not intended to hold my volatility trade into 2015. I believed a good Santa season would allow volatility to come in enough for me to get out but the continued descent in oil has left fear running amok in the markets. But is this fear rational?

Folks who are selling their 401k's in fear of another 2008 market crash that ensued as a result of the housing bubble pop should take a deep breath. There is a large difference between the bubble in housing and the bubble in oil.

When housing built its bubble, it did so by growing its investment base. Lower and middle income Americans bought houses with sub-prime loans inflating prices to well beyond what they could actually afford. All the while inflating house prices faster than income inflation.

According to U.S. census, the median U.S. income was $10,394 in 1975 while the median house price was $35k. This equates to 3.36 times annual salary to purchase a home. In 2005, however, the median income was $46,326 while the median house price was $220,000 or about 4.79 times the annual salary. Add sub-prime mortgages to this disparity and now you have people buying outside of their means by even larger percentages. In other words, the person with an income of $46k in 2005 was not buying a $220k house, he was likely buying a $300-400k house because banks were giving him the loan to do so and the average Joe was led to believe that this was his guide to future wealth. After all, most of us were told by our parents that property is the best investment we can make. I remember when the housing bubble was inflating. I was living in the San Francisco Bay Area and I would hear people say that we should all go out and buy the most expensive house that a lender would allow because this is the best investment we could make.

Fast forward a few years and everyone is invested to the hilt in housing. The rich and the poor alike were owning houses, along with banks and entire towns and counties. Entrepreneurs were popping up with small lending companies; bankers with a sketchy sense of ethics were creating derivatives of derivatives based on housing investments. When that bubble crashed, it hurt a huge number of investors from Joe the Plumber to the Too Big to Fail banks.

Crude Oil, on the other hand, has a relatively small investment base. That base consists of those who extract and sell oil, i.e., drillers and suppliers, funds that are largely invested in oil as well as banks who have made oil loans. Virtually everyone else stands to benefit from low oil prices. You and I benefit from low gas prices, enough to really make a difference at this point; retailers like Amazon (AMZN) benefit from lower shipping costs; importers and exporters, airlines, refiners all benefit from lower oil. The likelihood that a bubble pop in the price of oil will crash the entire economy is relatively low. The current reaction in equity markets to lower energy prices is largely fear based.

I don't believe that commodity demand is in a deflationary period overall. Demand is merely shifting. We are becoming more energy efficient, certainly, better gas mileage as well as other forms of energy like solar and wind means we use less oil. And the increase in production by Arab countries trying to keep up their market share is only adding fuel to the oil fire. But what about other commodities?

The backlash of Moms around the country at high fructose corn syrup amid terrifying reports of increased health issues has lowered the demand for the overgrowth of corn. Widespread reports of diseased livestock that are commercially raised, residual pesticides in the Dirty Dozen and now GMO's have families shifting to pasture raised meats and organic produce. The farm to table concept is gaining momentum as folks get tired of being fed what the U.S. Dept of Agriculture wants to force down their throats like so many fatty geese that have been banned from the state of California. And with lower oil, those folks have more money to spend on better food.

At some point in the near future folks will come to terms with the idea that low oil does not necessarily equate to another Great Recession as the housing crash did. That in fact, low oil can stimulate the economy. Once earnings reports start coming out in a few weeks, this point should become more clear. When market makers exhale, volatility will collapse. I am a patient enough Wife to wait for it. 

 

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