When You Trade Commodities, Forget About Stocks

This is the second of a two-part series of articles trying to explain why commodities don't act like stocks and can't be understood the same way. The word "speculation" has been applied to the dynamics of oil and general commodity pricing, and when it is, the words "manipulation" and "bubble" follow them shortly after.

Let me explain why these words don't apply, and we'll have a better idea of what levels oil and other commodities can reach.

First, we need to understand that commodity pricing is no longer being arrived at by the traditional users of commodity markets. In my first article, I described the nature of price discovery and talked about how legitimate buyers and sellers find each other using exchange contracts to arrive at fundamentally correct prices for corn, wheat, oil and other commodities.

In the last few years however, speculation, particularly indexed speculation, has swamped the volumes of legitimate participants and left them outside the system that was created for them. Farmers are less often utilizing the forwards markets, refiners cannot make a reasonable margin on $4-a-gallon gasoline, and OPEC ministers tell President Bush that there's no one left to sell oil to, even if they agreed to increase supplies, and they're not kidding.

So, if we come to the conclusion that traditional sources of price discovery have little influence on the markets, what is determining price?

Looking to Buy

Everyone wants exposure to oil and other commodities as a better return investment to stocks and bonds today. And there are not many places to go if you want to be exposed to (long) commodities. The NYSE offers more than 20,000 issues if you want exposure to stocks, but there are only two major oil futures contracts being traded today: WTI on the New York Mercantile Exchange and Brent Oil on the Intercontinental Exchange. There's a lot of fresh money showing up on these and other exchanges looking for exposure to commodities that until recently never looked for it before.

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At the time of publication, Dicker had no positions in stocks mentioned, but positions can change at any time.

Dan Dicker has been a floor trader at the New York Mercantile Exchange with more than 20 years' experience. He is a licensed commodities trade adviser. Dan's recognized energy market expertise includes active trading in crude oil, natural gas, unleaded gasoline and heating oil futures contracts; fundamental analysis including supply and demand statistics (DOE, EIA), CFTC trade reportage, volume and open interest; technical analysis including trend analysis, stochastics, Bollinger Bands, Elliot Wave theory, bar and tick charting and Japanese candlesticks; and trading expertise in outright, intermarket and intramarket spreads and cracks. Dan also designed and supervised the introduction of the new Nymex PJM electricity futures contract, launched in April 2003, which cleared more than 600,000 contracts last year alone. Its launch has been the basis of Nymex's resurgence in the clearing of power market contracts over the last three years. Dan Dicker has appeared as an energy analyst since 2002 with all the major financial news networks. He has lent his expertise in hundreds of live radio and television broadcasts as an analyst of the oil markets on CNBC, Bloomberg US and UK and CNNfn. Dan is the author of many energy articles published in Nymex and other trade journals. Dan obtained a bachelor of arts degrees from the State University of New York at Stony Brook in 1982.