Friday, December 19, 2008

Oil Enters Buy Zone

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. In addition to the term helicopter economics, we have also coined the term, helicopternomics, to describe the current monetary and fiscal policies of the U.S. government and to update the old-fashioned term wheelbarrow economics.

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At the extremes of sentiment, there is nothing more bullish than a bearish commodity. When oil got to around $12.50 a barrel in 1998, surveys showed that only 3% of traders had a positive price outlook . Within days it was trading over $17 a barrel. The turnaround was sudden and explosive. The few contrarians who saw the opportunity made a lot of money in a short period of time. It turned out that $12.50 wasn't the low however, that was in the $10 range and it took a few more months to reach it. Similar behaviour is possible this time around.

Nymex oil fell as low as $33.44 in overnight trading. This represented a sharp drop in 24 hours after more than five long months of steep selling. It is common for markets to have six month sell offs. It is also common for the selling to end with a big drop at the end. Keeping that in mind, I started buying OIL today, even though I do not think oil has hit its low just yet. I suspect that this will be somewhere between $22 and $28. The set up for a good short term trade or the beginning of accumulating a position seems to exist though.

As I have said many times, the bottom price of oil will be determined by the cost of production. This is much higher than it was in 1998 because there is less easy to get to oil available. Much of the oil that has come on line in the last few years is oil that is expensive to produce, such as tar sand oil from Canada. This supply will start disappearing with oil selling in the 30s and the loss of supply will become extreme in the 20s. While you can find any number of news articles about how the demand for oil is going down because of the economy, you will see little about the supply also decreasing, which is the bullish side of the equation. Economic arguments that deal with the demand picture without mentioning supply are meaningless and should always be discounted.

Oil is one of the four pillars of inflationary investing (along with gold, silver, and food commodities). Keep in mind that it is priced in U.S. dollars and the Fed basically said this week that it intends on printing any amount of currency necessary to get the U.S. out of its current depression (my word not theirs). Just last night the BOJ in Japan lowered interest rates to 0.1%. England will likely institute ZIRP sometime in 2009. With the world's central banks engaging in hyperinflationary policies, it is only a matter of time before the price of inflation-linked commodities skyrocket. You just need to time your entry and wait for that to happen.

NEXT: Bailouts: It's Not Just Banks, It's not Just the U.S.

Daryl Montgomery
Organizer,New York Investing meetup

This posting is editorial opinion. Like all other postings for this blog, there is no intention to endorse the purchase or sale of any security.