Thursday, September 20, 2007

Leverage Rising (Not a Tom Clancy Book)

This chart shows the absolute value of the change in price of unleaded regular gasoline as a percentage from one month to the next. The red line is a 3rd order polynomial attempting to make sense of the trend. It is intended to show if the magnitude of the changes in price (both when the price moves up AND when the price moves down) are increasing over time. I think it is fairly safe to say that gasoline price volatility is increasing. I have argued in the past that one reason might be because our society is becoming increasingly more leveraged (9,000+ hedge funds might agree with me). Another more obvious reason might simply be because we're at war (but the volatility seems to have picked up well before that point).

If it is the job of the Fed to promote price stability, I'd argue that in the long run they might be losing the battle. This does not offer any hints about what we as individual investors can do to protect ourselves though. The last thing we want to do is invest in something that will soon see a huge price drop (to offset the huge price rise that perhaps lured us in). The only thing this chart might tell us is to expect more chaos and less stability going forward. At the very least, it shows us how much chaos and lack of stability we have right now (in gasoline prices anyway).

Unfortunately, there's a reason the vix index (volatility index) is considered a fear index. Fear and volatility often go hand in hand. When looking at the above chart is is very safe to say that I am more fearful. Where does the price of gasoline head next? Does it go way up? Does it go way down? Or does it continue to gyrate between the two extremes (as it has in the last two years) in an attempt to keep us all off balance?

See Also:
Certainty vs. Uncertainty
Certainty vs. Uncertainty (animated)
Gasoline vs. Treasuries
1970's Style Growth
Gasoline Prices and the Business Cycle

Source Data: Motor Gasoline Retail Prices, U.S. City Average


Anonymous said...

Interesting graph!

Prices may be gyrating but the longer trend is clearly up.

One thing to remember is that the Chinese have only to break the RMB peg to the dollar while allowing wages to rise in their country. That will allow the RMB to soar against other currencies while also releasing tremendous demand from Chinese consumers. Seems to me the Chinese strategy is for the RMB to become the key currency (KC) by stealth. They have no real interest in trading the a dollar KC for a euro KC. Once they get enough traction via wage increases they can allow their currency to rise slowly but steadily. A strong currency is very good for a country that imports energy and food with a strong internal market for their own production of consumer goods.

The easiest path the Chinese have to sufficient sources of energy is by allowing their currency to appreciate against the dollar and the euro. But slowly and steadily so as not to precipitate a currency crisis.

If they are successful we can expect the price of gasoline in $US to rise for the forseeable future, US recession or not.

The Fed is irrelevant and a half point double shot across the bow isn't going to change the course of things one whit.

So, in spite of increased volatility, one can reasonably conclude that a barrel of oil is going to be worth a lot more than $US80 in a few years time.

Compare the gasoline price volatility with that of gold at its prior peak. A single summit vs: violent dithering. Quite different. This oscillation indicates there is a lot of doubt about what constitutes the real value of a gallon of gasoline. And we're talking about a market many times bigger than that of gold.

I think we're looking at an epochal change that is accompanied by violent moves in the value of energy vs: money. Every wave down is followed hard on by a new wave up.

Time to stock up on toilet paper, I say.

Stagflationary Mark said...

Just keep in mind that this does not show if the price of gasoline is rising or falling long-term (that would be an earlier chart). It simply shows that the volatility in the prices is increasing over time (or appears to be).

Another way to look at it is that more randomness appears to be happening (or that we're now playing in a casino).

There is some concern of mine that what took 15% interest rates to cause enough pain to stop inflation might not take anywhere near that this time. Maybe 5.25% was enough and we just don't know it yet. (I'm not betting that it was though.)

Can you picture the adjustable rate mortgage payments on the median house if interest rates hit 15%?

I can and it is well beyond ugly!

That being said, there's no harm in hoarding toilet paper. Been there, done that, doing that, will continue to do that. Thank you Costco!

I told my girlfriend to go nuts when buying Campbell's tomato soup this week and she brought home 25 cans. It surprised even me. It was a good price and I've got two years to eat it though so what the heck, lol.