Is Recent Oil Spike An “Irrational Exuberance”?

Many banks and investment firms have come out to defend the rise in oil prices saying that it is based on fundamentals and that prices could rise much further. While they go on saying this and prices move upward, open interest in crude futures contracts has been moving steadily downward since a high of 1.58 million last July to 1.36 million now. What’s more, in the recent oil spike, open interest actually fell 8% in a week as oil moved up over 2.6%. Could this be a sign of a short squeeze with small traders who had shorted oil closing their positions as major banks like Goldman Sachs [[gs]] predict oil will continue higher? Some might even think it was major banks tripping short stops so that they could exit their long positions at better prices.

But aren’t there fundamental reasons for this rise in oil prices? In some ways yes, demand from China and India is increasing, but at a slower pace than oil has gone up. In markets such as the US, gasoline prices have not moved up nearly as much as crude, squeezing refineries margins, and slowing their orders of crude, which shows that demand for gasoline isn’t justifying higher prices.

So is this recent rally be a short squeeze so that banks and funds can exit their long positions while small speculators are filled with “irrational exuberance” over the price of oil? Opec ministers might think so, they’ve said that the recent spike is caused by speculation rather than by an increase in demand and that their level of supply is more than sufficient. John Hofmeister, president of Shell Oil said that the “proper” range for oil should be somewhere between $35-$90 a barrel.

Meanwhile, those holding the bag of the last big bubble - housing - won’t be too happy to hear that home prices posted their biggest quarterly decline since the government started tracking them 17 years ago. The housing market is suffering from a double whammy of record foreclosures and a huge amount of real estate inventory left over from the boom days.

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