Expert View: The Texans are playing poker with oil again

Fashions change, and after months of obsession with US unemployment and the US Federal Reserve, the oil price has now taken over as the key indicator for markets. With the exception of short-term traders, such as in the foreign exchange markets, whether Alan Greenspan raises rates in June or August matters little. The fact is, US rates are headed higher, and bonds and equities have largely priced this in.

Importantly, this is largely a financial markets story, since the wider economy is relatively immune to a 1 per cent move in the price of short-term borrowing. In financial markets, which make their money out of small percentages on enormous amounts of capital, such a move is extremely significant and it is the end of the speculative bubbles built in all markets that has been the overriding characteristic of markets this spring.

But back to oil. It is with a wry smile and little surprise that I note the perma-bears claiming higher oil prices will now cause a recession. No wonder they call economics the dismal science. On this tortured logic, the increase in world demand that is causing oil prices to rise will imminently cause a depression. We are told that US consumers having to spend more money filling up their four-wheel drives will now have less money to spend on other things. No mention that part of the reason oil prices are higher is that Chinese industrial production is soaring and the same US consumer is now paying $50 rather than $550 for his DVD player.

Swings and roundabouts. Equally, the law of big numbers means that a rise in oil from $30 to $40 is not as significant as one from $10 to $20

As to oil going to $50, well it's possible, but not probable. While there is undoubtedly a bull market in oil, as there is in most commodities, driven primarily by the rapid expansion of China, there is also an enormous amount of speculative activity currently under way in the oil markets - much of it having come out of other markets in search of a trend to trade. There is an interesting parallel here with copper at the end of last year, where prices rose 50 per cent in three months and everyone justified it on the basis of fundamentals, China etc. But much of it was really speculation, so prices fell 25 per cent in the following three months - even though the fundamentals were unchanged.

One thing that could burst the speculative bubble - and leave oil prices nearer $30 than $40 - is a source of much speculation itself. Briefly, the US government has been building up a Strategic Petroleum Reserve of 700 million barrels of oil, buried deep under the deserts of New Mexico. We saw in 1991 that the mere suggestion of a release from this reserve caused a speculative bubble (oil had jumped from $22 to $37 ahead of the first Gulf war) to burst. Oil fell back to $22 and stayed there for a decade. Bill Clinton, too, managed to release stocks from the strategic reserve ahead of the last US election - although this was only "temporary", it brought oil prices down. None of this is about stopping real supply and demand, it is about countering speculation. As such, it's like a game of poker.

Bottom line, Oil is at $40. Will it be $30 or $50 come November? It's oil, it's poker, they're Texan. Your call.

Mark Tinker is a director of Execution Stockbrokers Mark.Tinker@execution-limited.com