Once upon a time, financial markets reflected supply and demand balances. Some players, the speculators, would use them to try and anticipate changes in these balances. Some players, the producers and consumers, used them to help stabilise their margins.
From time to time, the balance between the stabilisers and the speculators would be lost. Markets would then swing off temporarily in an odd direction, but would soon realign again with the fundamentals.
But not today. The chart above shows official weekly US oil and petroleum products inventory figures since 2008:
• 2008 levels (purple dash) were relatively low, causing prices to be strong till mid-year and the arrival of the financial crisis
• Since then, stocks have never been below the black line. This marks the peak inventory level at the end of 2008
• Yet prices have continued to be in the demand destruction zone, at 5% of global GDP
The problem is the simple one of 'weight of money'. Pension funds have become speculators in the markets - based on the conviction that commodities are a new asset class, alongside equities and interest rates. And they have the firepower to sustain the speculation for a long time.
If a large fund allocates 5% of its portfolio to commodities, it forces prices higher. And since 2009 their buying has created the commodity supercycle myth, as we describe in chapter 3 of Boom, Gloom and the New Normal. Equally, in this fairy-tale world, all news is 'good news'.
Even today's slowdown in China's economy can become 'good news'. No matter that it is partly caused by today's record high gasoline and diesel costs. Instead, the message goes out to 'keep buying' . Today's slow demand means the government will be forced into a major new stimulus programme, which will lead to even higher prices.
One day, of course, markets will return to their true function, of balancing supply and demand. But in the meantime, companies and consumers (whose money sponsors the pension funds) will continue to suffer from their speculative activities.