Oil as a Trap of Rational Interpretations


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Sergei Golubitskiy

25 Nov, 2016

in Commodities

“The greatest enemy of knowledge is not ignorance; it is the illusion of knowledge”. Stephen Hawking.

The participants of financial markets are possessed by a need for rational interpretations of reality which they are doomed to contemplate without a chance to change a thing. Something similar happened at the dawn of mankind when fear and weakness in the face of nature found consolation in a Supreme Devine Force suitable for «explaining» anything.

The major problem of rational interpretation of the events happening in the financial markets consists not in its uselessness but in serious material losses it entails. Today we will attempt to reveal the pitfalls laid by rational interpretations using oil futures as an example.

In the summer of 2014 both WTI and Brent grades of crude oil started a free fall causing a global change in the development of world economies. Suffice it to say that as a result of the dramatic oil price depreciation Russian Currency Rouble lost half of its value within several months.

Sanctions and — to a greater extent — counter sanctions sped up the involution of the Russian economy heavily dependent on exportation of raw materials, and pretty soon the Brent price became almost an exclusive booster for the local stock market. Oil goes down — Rouble goes down — both Russian market indices — MCX (valued in local currency) and RTS (valued in USD) — go down too. One could trade this dependency fool-proof.

It might look strange that a single factor, even such important as oil, could supersede in the eyes of the stock market the entire diversity of economic, social and political reality of a big country. However psychologically the explanation for this phenomenon is pretty obvious. If the Russian stock market would have been guided by the real economy drowned in gloomy predictions, the value of RTS index would be 90 points instead of 900 as of today.

Stock exchange is a living organism and similar to a human being it can’t survive in a fully negative environment. No wonder the financial markets constantly catch at a straw trying to justify their positive motion.

In January 2016 the Russian stock market found such straw in the same oil which suddenly stopped its overwhelming collapse (in 19 months Brent lowered from $105 to $27) and switched to an even dizzier ascent winning back more than 30% of its losses in just 5 months.

Since oil has become a sole motive for fluctuations of the Russian stock market traders and investors instantaneously turned into oil-and-gas experts dexterous at giving rational interpretations for each and every move of The Feeding Mom («Matushka Kormilitsa» — Russian traders slang for the oil).

In January 2016 all grounds for rationale suddenly washed away. It was easy to give logical explanations to the drop in oil prices since it occurred simultaneously with a dramatic increase both in production and reserves. However, the switch into rally happened when the growth of production and reserves accelerated even further due to the removal of sanctions against exports of Iranian oil and the inability of OPEC countries and Russia to negotiate at least a freeze of production at current levels. Hundreds of tankers queued at big harbours in wait of unloading only completed the gloomy picture.

When the rational logic comes to grief there is always conspiracy theory ready to extend a helping hand. «The oil had to drop initially because there were overstock and overproduction, — assert newly-fledged experts, — but today it must rise because the insiders know a horrible secret: no matter how much you boost the production the demand for oil will inevitably exceed all bids in the nearest future!»

Alternative conspiratorial rationale: the insiders acquired some secret information about oncoming geopolitical upheavals (a war?) which will result in the oil prices equal to that of gold!

Finally, there is always an old ruse at hand borrowed from the legacy of formal fallacies: in our case — ignoratio elenchi or irrelevant conclusion: it’s of no concern that the crude oil production keeps on growing and the warehouses burst since there is a chronic shortage of its fractions — gasoline, kerosene, HFO etc. — and it justifies further price increases.

All these clumsy attempts to rationalise trend changes in oil futures are pure crystal gazing because the market movements are not the reflections of reality but a product of our mythological perception multiplied by fine manipulation techniques.

The markets are originally endowed with a centrifugal force which tears the behaviour of securities from their formal raison d’etre i.e. business activity of their issuers in the real world. This alienation became the further the stronger and in the mid 90s it reached its apogee when the financial markets started to live their own independent lives.

The reason for this complete alienation of the markets from the real world lies far from any conspiracy theory and is pretty obvious: the further the economy develops the trickier become its backbone connections.

At a given moment the influences of the real world over financial markets become so multifaceted that they simply fail further rational accounting. Externally this condition looks like a cause-and-effect entropy, complete chaos which is impossible to explain logically.

In a situation where the price changes in the market are determined by a vector compounded of myriad reasons the majority of which are publicly unknown, any attempt to give a rational explanation to these changes looks ridiculous.

Market movements are the products not of individual motivations but of the mob psychology. This main motivation of this mass consciousness constitutes mythological thinking based on imaginary, emotional, irrational and the priority of bright images.

In our example with crude oil prices the attempts to rationalise their erratic movements are conditioned by unconscious thanatophobia, fear of death, associated with sharp drops in petroleum prices. In the collective subconsciousness of market participants there is a strong notion of an economic collapse inevitable in case of oil prices falling below $ 10.

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