Thursday, July 5, 2012

Why You Shoud be Bullish on Crude Oil

With a recession now more and more likely, common sense should say to stay out of commodities, including crude oil, until the storm is over. However, in the case of commodities, the best time to buy is when there is a glut, and sell when there a price spike due to a shortage (which seems to have started with agricultural commodities recently).

Crude oil is no exception, and depending who you listen to, break even prices for new oil fields range between 70 to 90 dollar per barrel, which means that if the price goes below 70 dollars, companies will stop investing to add capacity and in the long run, prices will have to go lower. It's almost a no brainer.

Another long term advantage with crude oil is that global reserves are declining, and it looks like we may have reached conventional peak oil in 2005. At some point, new technologies such as oil shale and fracking, as well as a better use of natural gas, will eventually put a ceiling on how high crude oil price will be. In the meantime, it's probably wise to prudently buy crude oil between $70 and $90, and buy aggressively if it falls below $70. As long as you don't use leverage you should be just fine.

Jim Rogers has recently been interviewed on, where I gave his outlook for crude oil.
Here are the key points:
  • Crude oil is in a correction, because of the economy, Saudi Arabia might try to help Obama get re-elected, and JP Morgan may have unauthorized positions they're having to liquidate.
  • $40 crude oil is possible, but that would just setting up crude oil for an even more bullish scenario for the duration of the bull market.
  • If natural gas stays this low compared to oil prices, it does give an incentive to develop natural gas powered vehicles.  Is it going to end the use of oil, combustion engines? Probably not any time soon. Someday it could, but someday is a long way away.
  • Iran and Iraq appears to get closer together which could eventually have an effect on the market
  • He does not know enough about shale gas to comment about it, but said it won't have a serious impact for years to come.
If crude oil is such a good long term investment opportunity, how do we invest into it?

First, unless you plan to trade for a few weeks or months, do not buy USO, it's a terrible long term invesmtent due to high cost and contango effect. You could invest in futures, but it's not for everyone. They best way could be to invest in companies such as TOTAL or BP for the next few years, but in the end due to declining reserves, and demand destruction, profits may fall even if prices go up. Instead of only buying crude oil, you may consider investing in an ETF tracking commodities index such as RJI. Since other commodities are also indirectly subject to the price of crude oil, RJI has about 40% crude oil exposure (WTI and Brent) and seems to suffer from less decay.

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