I’ll never forget receiving my first pyramid scheme letter.
Send $5 to the name at the top of the letter and cross that name off the list. Write your name at the bottom and send to 10 of your friends. Do this, and riches will surely follow, the letter said. More specifically, was the promise of thousands of dollars in your pocket just for playing along. The letter was remarkable in its simplicity, and devilish in its promise. The only problem, of course, was that the scam was entirely illegal. Those sending the original letter with their names at the top were the only one’s enriched by the scheme.
Variations of these letters exploded on the American scene during the 1990s and grew exponentially with the advent of the Internet. With a sucker born every minute, perpetrators of the scam had no trouble finding willing victims. Get rich schemes work because they feed on irrational dreams of the hopeless. Those that are stuck in low paying jobs, unemployed-or simply uneducated, have the same desires as those who have supposedly made it in economically. They want to believe so badly their actions take leave of sense.
In the early 1900s, the stock market had plenty of its own pyramid schemes. Sellers of companies with no assets or prospects easily preyed on the unsuspecting investor by offering stock that had the potential to grow in value. If a buyer wanted to exit in the early stages of the scam, the ringleader would usually find a buyer willing to step in. When the scheme was really hot, the price of the stock went up, up and up. It was all so perfect until the music stopped. And stop it did in 1929 with those left literally holding the bag of worthless paper.
Fast-forward to today, and another pyramid scheme is working its scurrilous magic. This time, the action is in the oil pits. There, speculators are chasing after contracts that allow for the delivery of crude at some point in the future. With the convenient use of massive amounts of leverage, traders can take very large positions with very little capital required. Since most of these so-called investors have zero intention of taking delivery on the contract, the hope is that they can find a buyer who will gladly pay higher price down the road.
What is happening in oil stocks today is no more than a pyramid scheme. And when the music stops, somebody is eventually going to get burned.
Personally, I can’t wait to see it!
Joe Blow goes chasing a dream by participating in the oil futures market. When there is no buyer to be found for his contract, he will find… >100 barrels of crude sitting on his doorstep! Of course that won’t happen, but what will happen, is Joe Blow will be forced to sell his contract at a big loss (for those of you looking for a commodities 101 refresher course, you’ll want to read “Commodities: Your Guide to Profiting Smartly“).
By my estimation, oil has about $60–$80 of such excess priced into the market at the moment, and by all accounts, that number is expected to grow over the next several months as more suckers are found.
Hedge funds dominate the trade currently, but mutual funds led by the all powerful oil exchange-traded funds are buyers as well. Fast on their heels are the individual investors who are dreaming of easy money. There is no such thing, and this dream will come crashing down at some point. My best guess is that the end will draw near sometime after the election.
For now, an Iranian surprise or some other going out with a bang Bush led Middle East excursion could push oil prices beyond the $150 mark. At a minimum, there are more suckers out there that will be the buyers for those at the top of the pyramid. My advice: Don’t get suckered into this losing bet. Instead, take a look at Richard Young’s Intelligence Report. His subscribers will find plenty of Rational ideas that don’t depend on pyramids … or suckers!
Stop burning a hole in your portfolio with overpriced oil plays. Sign up for your risk-free trial subscription to Richard Young’s Intelligence Report and he’ll show you which top producers are raking it in for his Intelligence Report subscribers!
