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Signs point to the next Oil Bubble, and the economy will suffer

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In 1998, crude oil reached a relative low of approximately $10 a barrel. Ten years later, in 2008, oil was peaking at the $145 per barrel mark. What a nice ride it was for oil investors. But from 2006 to 2008, it showed all the signs of a relative peak, caused by a speculative bubble.

At the macro level, everything is rising in price compared to the US Dollar. We all know this. It's due to monetary inflation by the Federal Reserve and US Treasury, commonly referred to as "printing money". But this monetary inflation tends to jump from bubble to bubble, rather than evenly flowing through the economy. When the Housing Bubble started popping in 2006, it was time for the "smart" money to move to the Oil Bubble (with the Housing Bubble being preceded by the Dot Com Bubble). It's always a search for the next commodity, asset or investment to use as both a speculative vehicle and an alternative currency.

The last time that oil entered a major speculative bubble in 2006, there were signs that the bubble was going to occur (other than a slowly rising price). Those same signs are present again. It starts with analysts from the biggest financial firms predicting higher prices in the near future. It also goes without saying that if these big firms are positioning themselves in the given investment vehicle, there is an element of self-fulfilling prophesy and conflict of interest in those predictions.

The second sign of the Oil Bubble was news reports indicating a general consensus that the price was going to rise. There is always a myriad of reasoning that goes along with this consensus, suffice it to say that the idea that the price of oil is going to rise, and rise soon, is in agreement. This usually coincides with an actual rise in the price of gasoline, and media publicity about the current and future price. It is worth noting that the price of gasoline often rises before crude oil rises in price. By coincidence or intention, it serves to increase awareness in the general public.

The third sign is media reports highlighting "failures" in the oil industry: a pipeline shut down for maintenance, a few oil rigs out of service, an oil field in the Middle East facing production problems. This serves to intensify the urgency to get in while there is still time.

All of these factors are now in play, and we can expect the price of oil to rise dramatically, according to prediction, with the biggest winners being the early adapters in the bubble. Would it be a coincidence if the biggest winners are the same people that started the ball rolling? That remains to be seen.

Relatively speaking, this bubble will once again burst, as speculative bubbles always do. This will not change the fact that in a macro sense, continued monetary inflation will result in continued price inflation, but it will make for some profitable "froth" on the way up.

But how long will an Oil Bubble last? Unlike many other bubbles, an Oil Bubble is extremely damaging to the entire economy. It effects nearly every aspect of our personal and business lives. The actions of a bubble in oil are analogous to a huge tax being levied at all levels on the economy. Unlike the subtle and hidden damage of monetary inflation, an Oil Bubble will be obvious and brutal in it's destructive force. Pressure will mount quickly and strongly for a solution. How long it takes for pricing to return to normal will depend upon the political agendas at work. History teaches us that the bursting of the bubble will begin when the biggest and longest players in the bubble suddenly take their profits and run. Like a huge pyramid scheme, the initial players will be the winners, with many more being the losers. In the case of an Oil Bubble, the entire economy loses.

On the bright side, like real estate and gold, the price of oil will never reach zero, but it may feel like it for the people who lose out and can not wait long enough for the given commodity to return to it's long term trend, if it returns within their lifetimes. Many losers in the Housing Bubble are still wondering when the bottom will be reached. That wait may be very long indeed.

Updated 01-13-2011 at 10:35 AM by Brian4Liberty (Condensed for clarity.)

Tags: Oil