This from Dan:

It seems pretty obvious, that for the last ten years anyway, selling stocks and buying gold would have been a good trade/strategy. Stocks ended an 18-year bull market in 2000 and gold ended a 20-year bear market. One asset class was at a cyclical low. The other was at a cyclical high. In fact, you might even say that one was at a generational low and the other was at a generational high.

Gold is no longer as low as it once was. But it’s still not as high as we expect it to go before it starts to look foolish. Meanwhile, today’s government bond market looks an awful lot like the stock market circa 2000. You’re seeing a generational high in bonds. It’s another version of the “high-low” strategy.

This time around, though, we would add energy stocks to the mix, along with gold. Crude oil climbed to an eight-month high over $70 on Tuesday. Bloomberg says the weakness in the US dollar is, “bolstering the appeal of energy as an alternative investment.” Sell bonds, buy energy. Pretty simple.

There is probably some truth to the fact that oil’s latest move is driven by investment demand more than, say, demand growth in the real economy. But investors ARE looking for ways to profit from US dollar weakness. Oil is liquid and popular. In the long-run, it’s the smaller-than-expected oil supply growth that will drive the market.

TheDailyCrux.com editor Sean Goldsmith says one way to play commodities this year is buy going long natural gas. That’s because according to a recent Bloomberg survey natural gas prices will rise 38% this year…

Natural gas’ 31% decline in 2009 makes it the year’s worst-performing commodity. And it’s the cheapest compared to oil since the Soviet Union collapsed in 1992 and Russian supply plummeted.

Gas is down 72% in 11 months as the recession destroyed demand and drillers failed to idle rigs fast enough to contain supply. Today, stockpiles are 22% higher than the five-year average. And oil costs 18 times more than gas.

Now, the drillers are finally slowing production… Just as the economy is showing signs of strength. The number of rigs dropped 56% in the past nine months – the most in two decades – to around 700. According to Bloomberg analyst surveys, natural gas prices will rise over 38% this year.

But, now I think oil has bottomed and will head higher. My fundamental and technical indicators are pointing to higher oil prices.

It’s disappointing that Americans seem to forget about our dependence on foreign oil as oil prices drop. In the 1970’s we got a wakeup call when people experienced gas shortages and rising fuel costs. Then it happened again, when oil spiked up to $147 a barrel last July. You heard lots of talk of switching to electric cars and cutting off our addiction to foreign oil. It’s disheartening that you don’t hear much about this anymore because now we have our cheap gas again.

We need to wake up and focus on finding alternatives to gasoline as the power source in our automobiles. It is time to get off this quickly depleting natural resource. Now that oil is cheap again we see people going right back to their old ways. Americans are starting to buy gas-guzzling SUVs again and the carpooling trend is tapering off. Oil demand will return and oil will go higher again.

We might as well profit on the next surge in oil prices. I think we are looking at a spring rally. The bottom in crude back in December was at $32.48 per barrel. This will likely serve as the low in this cycle. I circled crude oil’s highs and lows on the 5-year chart below to give you a perspective.

Here are just a few reasons why I think oil will run higher:

• There are many potential geopolitical flash points around the world that can flare up at any moment which could disrupt oil supply
• OPEC plans to meet Sunday in Vienna, and a few of the cartel’s leaders have said more production cuts are to be expected
• Crude oil prices held up in the face of new 12-year lows in the stock market last week; this is very bullish for oil
• Oil exploration companies increasingly drilling for oil in harder to reach places, and this adds to the cost of exploration and results in higher oil prices
• Most of the world’s cheap oil has already been discovered, and many experts think the world is running out of oil
• Soon we could see demand increase to a level that will start to exceed supply. Demand will grow in the years ahead as India and China continue to modernize.

While oil inventories are high right now, they may start to decline towards the end of the year. I suggest you start looking at investing in oil over the next few months and use big down days as buying opportunities.

If you invest in oil, keep an eye on the economy. If the current slowdown gets worse and last longer than expected, it could have negative effects on oil prices. Currently my indicators are pointing to higher oil prices in the near term.

The world’s utter dependence on oil remains unchanged. I believe the upside for oil prices is now much greater than the downside in the near term. I think the worst of the great oil bubble burst is behind us.

My esteemed colleagues wrote some great articles on oil recently. Dr. Russell McDougal wrote a great article on oil titled “Don’t Get Comfortable With Cheap Oil. And, Steve McDonald wrote an excellent piece titled “$75 Oil This Year and it Can Put a Lot of Money in Your Pocket”. I suggest you read their articles; they give some great ways to profit as oil prices rise.

Source: It’s Time to Invest in Oil Again!

U.S. oil prices climbed towards $38 a barrel on Monday after the International Energy Agency (IEA) said there could be an oil market supply crunch from next year once global oil demand begins to recover.

The IEA warning gave upward momentum to a market undermined by a raft of bearish economic data from Asia.

Japan’s economy shrank in the last quarter by its most since the first oil crisis in 1974, hit by an unprecedented slump in exports, which is likely to lead to more calls for extra stimulus steps to fight the deepening recession.

The impact of the recession is also being felt in South Korea, where January exports dropped by a record 33.8 percent from a year earlier, even worse than forecast.

U.S. light crude oil futures for March delivery were up 20 cents at $37.71 a barrel by 1304 GMT in electronic trade, after gaining $3.53 on Friday. The New York Mercantile Exchange is closed for Presidents Day and will reopen on Tuesday.

London Brent crude for April rose 8 cents to $44.89, maintaining a premium to U.S. oil due to high stock levels at the main U.S. storage hub in Cushing, Oklahoma.

The IEA’s executive director, Nobuo Tanaka, told reporters on the sidelines of a conference in London he expected world oil demand to resume growth from next year, rising by about 1 million barrels per day (bpd) in 2010.

SUPPLY CRUNCH

“Currently the demand is very low due to the very bad economic situation,” Tanaka said.

“But when the economy starts growing, recovery comes again in 2010 and then onward, we may have another serious supply crunch if capital investment is not coming,” Tanaka said.

Analysts see most oil prices trapped within a fairly tight trading range for the time being.

“We continue to maintain that crude prices will be trapped in a sideways band for the next several weeks,” brokers MF Global said in a note to clients. “Rallies above $50 look vulnerable, as given the deteriorating global macro backdrop, we do not think prices north of that level will be sustainable.”

Oil’s jump on Friday was largely boosted by renewed optimism that a giant U.S. stimulus package could help pull the economy out of a 14-month recession, while the gains were further encouraged as traders booked profits by selling the spread between front and second month futures contracts.

U.S. President Barack Obama on Saturday hailed congressional approval of the $787 billion economic stimulus bill as a major milestone in the country’s economic recovery and the White House said he would sign the legislation on Tuesday.

Obama’s aides warned Americans Sunday not to expect instant miracles from the bill but said it would help eventually.

Oil prices have tumbled from their peak above $147 a barrel last year, as the economic downturn has spread to all regions of the world, cutting energy consumption.

Analysts see downside risks for oil, as economies struggle through their worst recession in decades.

World oil demand will contract more sharply than expected this year due to the economic crisis, OPEC said on Friday, an outlook that may bolster the case for further supply cuts when the group next meets in March.

U.S. economic data due to be released on Tuesday include manufacturing production in New York State and U.S. home builder sentiment for February.

Source: LONDON, Feb 16 (Reuters)

Oil climbed towards $42 a barrel on Monday after OPEC said it was willing to cut oil output further if needed to stabilise oil prices.

The market was also supported by a giant U.S. economic stimulus package that the administration of U.S. President Barack Obama is expected to get through Congress this week.

U.S. crude for March delivery rose $1.67 cents to $41.84 a barrel by 1448 GMT. London Brent climbed $1.45 cents to $47.66.

“If we think we still need more action, I’m sure the conference will take more action to stabilise the market,” the secretary-general of the Organization of Petroleum Exporting Countries, Abdullah al-Badri, told reporters in London. He was referring to OPEC’s supply policy meeting on March 15 in Vienna.

Badri also said the 12-member group appeared to be implementing promises of production cuts more thoroughly than expected by some in the oil market with 80 percent compliance.

OPEC has said it will cut oil supply by 4.2 million barrels per day (bpd) from its level of production in September in an attempt to bolster oil prices that have fallen from a record high of almost $150 a barrel last July.

Harry Tchilinguirian, oil analyst at BNP Paribas in London, said the market was also looking ahead to the passage this week of a massive economic stimulus package to try to revive the U.S. economy.

STIMULUS

“The stimulus package is a supportive structural factor,” he said. “It should begin to have an impact on the economy in the second half of this year and is an underlying element conditioning sentiment.”

Top aides to President Obama on Sunday urged Democratic and Republican lawmakers to set aside political differences and quickly approve the stimulus package this week, as the world’s largest economy suffers from the worst financial crisis in 70 years.

Later on Monday, the Democratic-led Senate, with the help of a handful of Republicans, was due to vote to end debate on the $827 billion plan to clear the way for its passage on Tuesday.

Oil prices fell on Friday after news of steep job cuts in the United States, where nearly 600,000 jobs were slashed last month, the most severe cut since December 1974 prompting worries of still weaker demand in the world’s biggest oil consumer.

The financial malaise, which first sprang from home loan defaults in the United States, has swiftly spread to Europe and Asia, pushing a string of industrialised nations into recession.

Renewed violence in Nigeria also helped buoy oil prices. Nigerian militants attacked a gas plant operated by Royal Dutch Shell in the Niger Delta on Saturday and warned of more attacks to come, but the army said it had repelled the raid and killed three gunmen.

LONDON, Feb 9 (Reuters)

This from Rude Awakening:

As crude oil languishes near a 5-year low of $35 a barrel, forward-looking investors have good reason to suspect that a new bull market is about to begin. Sure, oil prices might continue slumping over the near term. But don’t kid yourselves; the long-term price trend is up…maybe way up.

Back when oil was selling at $147, I said that the world does not run very well at such lofty energy prices.  A lot of things just stop working at $147 for a barrel of oil, particularly things with a large energy component.  The airlines come to mind.  So something had to give.  The world economy could crash (no jokes about airlines here…), or the price of oil could come down.

As it turned out, we had both events.  The world economy hit the wall, and the price of oil came down in almost a straight line over five months. And gasoline is cheap again, which is a welcome salve for our ailing economy.

Let’s think through some of the macro-benefits of cheaper gasoline in the U.S.  The U.S. Energy Department statistics state that the nation burns about 9.4 million barrels of gasoline per day.  That’s about 395 million gallons (at 42 gallons in a barrel).  Let’s say a gallon of gasoline is $2.75 cheaper than it was back in July, when I was paying $4.40 per gallon.  Take 395 million gallons per day, times $2.75 savings per gallon.  That’s almost $1.1 billion PER DAY that U.S. consumers are saving at the gasoline pumps.  That’s over $32 billion per month of savings, or nearly $400 billion per year.

In a sense, the world oil industry has given the American people a huge tax cut.  Or call it a “bailout bill” for consumers, except that Congress did not borrow the money to fund it.  And that $400 billion is not just money coming out of the hides of Big Oil and those bêtes noirs like Exxon-Mobil or Chevron.  No, this is a $400 billion cheap-oil tax cut paid for by the Sheiks of Araby, and Mr. Putin of Russia, and Generalissimo Chavez of Venezuela, and Mr. I’m-a-Dinner-Jacket of Iran.  Could not happen to a nicer bunch, eh?

But no good deal is entirely a good deal.  Just as the world does not work too well at $147 oil, the energy industry does not work well with oil at $35.  If $147 oil was a problem, then $35 oil is actually NOT the solution.  Cheap oil might even be worse for the world over the long term.

What do I mean?  Well, at $35 per barrel of oil, the incentive for energy efficiency and conservation is not high.  Heck, people are back to buying SUVs, if they can get a car loan.

And low oil prices are a major stumbling block to building out the next generation of energy systems like advanced windmills, solar, geothermal, tidal power and advanced biofuels.  Really, the world needs these items sooner or later.

Also, the traditional energy industries need prices about $75 or so to keep up levels of investment in new projects that require several years to build out.  That’s just to try and maintain current levels of fossil fuel output, which are declining in any event.

That is, world oil production has already peaked at about 86 million barrels per day.  We were probably never going to change that overall fact of energy-life back with oil at $147.  But we sure aren’t going to change it now that oil is selling at $37.  It’s the Peak Oil argument.

Depletion, of course, is still with us all day and every day.  Indeed, we could see swift declines in oil output from some major oil provinces of the world.  Mexican oil output is already declining fast.  Russia may shock us in 2009 with significant decreases from some older fields.  Saudi Arabia is problematic, despite all the happy talk from Riyadh.  The problem is that most of the world’s oil comes from giant fields that were discovered more than 25 years ago.

When people say things like “There’s still a lot of oil out there,” they are not necessarily wrong.  But they mean that there is a lot of oil out there that is NOT in giant oil fields. It’s oil that you will not drill up with just a relatively small number of high-output wells, like in the big oil fields of Saudi or Russia.

The “lots-of-oil” crowd is talking about hydrocarbon molecules (not necessarily light, sweet crude either) in deposits that are more dispersed, further out, in deep water, under more rock or salt layers, with higher temperatures and pressures.  Or they are talking about heavy oil, or bitumen in tar sands, or kerogen in oil shales, or even some transformation of coal.

When people use the expression “lots of oil,” they mean the expensive stuff.  It’s oil that requires many expensive wells or immense processing facilities, drilled or built with technology that we have just barely invented.  And it’s the oil that you will never see if prices stay at $35 per barrel for long.

That’s why oil probably won’t stay at $35 per barrel for very much longer.

Source: The End of the Oil Bust

The current curve looks almost the same as it did 10 years ago, when Russia’s default drove oil prices to drop as low as $10.82 a barrel in late December 1998 – a decline of nearly 40% from where they began that year.

At that time, the Organization of Petroleum Exporting Countries (OPEC) responded by cutting output by 1.71 million barrels per day (bpd), an amount equal to 7% of the group’s total supply, setting the stage for a 1999 rally in which prices more than doubled.

Fast forward to the present. OPEC, having witnessed oil prices plunge from a record high $147 a barrel in July to just over $30 a barrel at the end of December – an astonishing 80% decline – OPEC has pledged to slash its total output by 9%.

The cartel, which controls about 40% of the world’s oil production, on Dec. 17 pledged to cut production by a record 2.2 million bpd starting in January. Combined with previous cuts announced in October, the pledged output reduction totaled 4.2 million bpd, or 5% of global oil supply.

However, even with the announcement, some analysts were skeptical that member nations would follow through with the planned cuts.

At this point, it doesn’t appear that the cartel is bluffing.

OPEC oil supply fell in December for a fourth consecutive month as members implemented a deal to cut output, a Reuters survey showed yesterday (Tuesday).

OPEC crude supplies fell to 30.6 million bpd in December from 30.75 million bpd in November, according to the survey that included oil firms, OPEC officials and industry analysts.

The survey also found that OPEC countries pumped 27.36 million bpd in December, down from 27.62 million bpd in November.  That means the group has met virtually all of its pledge to lower supply to 27.3 million bpd from Nov. 1.

In addition, Angola, Qatar Iran and Kuwait all announced further cuts to production this week.

Kuwait will cut oil supply by 10% from Jan. 22 to buyers in the United States and Europe. The country has pledged to reduce output to 2.22 million bpd in line with OPEC’s new quotas. The country pumped around 2.45 million bpd in December.

Qatar will reduce shipments of oil sold under long-term contracts by as much as 6% in February, compared with 5% in January.

Iran has told at least two buyers that term supplies would be cut by 14% in January, sources with the customers told Reuters.

Sonangol EP, Angola’s state-owned oil company, has also asked operators such as Exxon Mobil Corp. (XOM) and BP PLC (ADR: BP) to cut crude production to comply with the OPEC quota.

Saudi Arabia, OPEC’s largest producer, is expected to release its allocations for February, as early as this week.

“Any clear sign from OPEC producers of compliance to announced cuts will, at a minimum, put a floor in prices,” Jonathan Kornafel, Asia Director of Hudson Capital Energy LLC, told Reuters. “The larger the act of compliance, the more likely we will see a sustained rally in crude prices.”

OPEC said Monday yet another extraordinary meeting will be held in Kuwait in February to discuss oil prices. Its 152nd regularly scheduled meeting is then set for March 15 in Vienna.

Source: Oil Prices Could be Ready to Rally if History is Any Indication

Oil fell below $40 a barrel on Tuesday, pressured by gloom about prospects for world economic growth which outweighed heightened tensions in the Middle East due to the Israeli-Hamas conflict.

Prices had jumped as much as 12 percent on Monday after Israel launched its fiercest air offensive in the Hamas-ruled Gaza strip in decades.

U.S. crude was down 77 cents at $39.25 a barrel by 1151 GMT, having earlier touched a session high of $40.39.

London Brent fell 60 cents to $39.95.

“With most global economies struggling and credit markets still in an impaired state, it is hard to get too excited about the upside potential in energy markets attributable solely to geopolitical factors unless, of course, these are directed at the heart of the oil supply system,” said Edward Meir of futures broker MF Global.

Oil is heading for a loss of nearly 60 percent this year, its biggest annual fall since futures began trading 25 years ago. It has dropped more than $100 from a record peak above $147 a barrel in July.

“People are still wary of the global economic problems. There is still pessimistic news coming out of the States,” said Gerard Rigby, an analyst at Fuel First Consulting in Sydney.

He said he would also be watching the dollar and stock markets moves.

The dollar slipped against the euro and a basket of currencies, depressed partly by the Israeli offensive, which has helped to dampen dollar sentiment.

The Organization of the Petroleum Exporting Countries has agreed its biggest-ever production cut of 2.2 million barrels per day (bpd) to fight the oil market slide.

The group has cut output three times in an effort to remove about 5 percent of world supply.

OPEC oil supply, excluding Iraq and Indonesia, is expected to fall by 400,000 barrels per day in December as members boost compliance with their deal to reduce output, consultant Petrologistics said.

The estimate indicates OPEC has more than delivered on its pledge to lower supply from 11 members to 27.3 million barrels per day from Nov.1 to prop up prices.

A poll of analysts forecast that U.S. crude stocks will have fallen by 1.4 million barrels last week, while distillate inventories will have risen by 1 million barrels and gasoline stocks increased by 1.5 million barrels.

Weekly U.S. fuel inventory data is due on Wednesday.

LONDON, Dec 30 (Reuters)

Oil leapt 6 percent on Monday to more than $43 a barrel, as a rebound in global equity markets and further evidence of supply cuts by top exporter Saudi Arabia helped the market break a six-session losing streak.

Prices dropped 25 percent last week, their biggest weekly fall in nearly 18 years, depressed by the world economic outlook.

U.S. crude for January delivery was up $2.56 to $43.37 a barrel by 1003 GMT. It fell more than 6 percent on Friday to close at $40.81, its lowest since December 2004.

London Brent crude rose $2.56 to $42.30 a barrel.

“Prices are higher on account of a short-covering bounce from extremely oversold conditions,” Edward Meir, of futures broker MF Global, said.

“OPEC’s meeting is nine days away, meaning that we could see some strengthening leading into the meeting,” he said.

Oil has fallen more than $100 a barrel from a record peak above $147 in July, as the credit crisis has started to hurt the wider economy and shrink demand for fuel.

Members of the Organization of the Petroleum Exporting Countries have called for more supply cuts when the producer group meets on Dec. 17 in Algeria.

SAUDI CUTS BACK

OPEC has already agreed to cut about 2 million barrels per day (bpd) of production. Top exporter Saudi Arabia has just provided further evidence of its intent to keep the taps tight.

The kingdom told at least two oil refiners in Asia on Monday it would deepen oil supply cuts to as much as 10 percent of normal contracted volumes in January versus a 5 percent cut in December supplies. It also reduced January supplies to some European refiners.

But OPEC may need to make an additional cut of as much as 2 million bpd to bolster prices in a market where demand is falling.

“The current downturn in prices has already priced in at least a 1.5 million bpd cut,” Tetsu Emori, a commodities fund manager at Japan’s Astmax Co. Ltd, said.

Monday’s rally spanned the commodities complex, with gold and copper rebounding strongly. European shares were firmer after strong gains in Asia.

Oil’s steep losses on Friday followed a U.S. employment report which showed the heaviest job losses in 34 years in the world’s top energy consumer.

But global markets have taken heart from efforts by Washington to finalize a rescue for the struggling U.S. auto industry.

Oil could also find support from predictions of a cold winter in the United States, with December set to be the coldest since 2000 on average.

Jane Merriman, Osamu Tsukimori, Jonathan Leff
LONDON, Dec 8 (Reuters)

Martin Hutchinson in Money Morning blames Fed inspired inflation and speculators:

The reason for this intense advance in commodity prices is that the Fed and its European counterpart have been pumping money into their respective economies to prevent the collapse of several major banks. The St. Louis Fed’s “Money of Zero Maturity” (the best broad money-supply measure left over since the central bank stopped reporting M3 money-supply statistics in March 2006), is up at an annual rate of 17.6% during the last six months. In Europe, Euro M3 is up at an annual rate of 10.8% during the same period – still double the growth seen in nominal gross domestic product (GDP).

In the key emerging markets, the money supply has been rising even faster – 19% in China over the past year, and 21% in India. Not surprisingly, those countries’ inflation rates are taking off, with India into double digits and China quickly getting there.

He goes on to say:

It’s fairly clear to me that concerted speculation by hedge funds and pension funds is what’s been pushing up oil prices. But that may be playing out – and reaching its limit – as the huge price increases we’ve seen in “black gold” over the past year is finally dampening consumer spending both here in the United States and in other key markets worldwide…

Dave Gonigam in Daily Reckoning sees oil supply as the problem:

…Oh, and those darn speculators. OPEC loves to blame them, and has blamed them, going at least as far back as $92 oil eight months ago.

BP (NYSE: BP) chief Tony Hayward is having none of that, calling the notion of speculators driving up the oil price a “myth.” More relevant, he told the World Petroleum Congress, is that “supply is not responding adequately to rising demand.” But then Hayward goes off the rails when, according to Reuters:

He added that politics rather than geology was the reason. “The problems are above ground not below it,” he said.

Now it’s true enough, as Hayward complains, that OPEC nations don’t like having Western oil majors like BP working OPEC oil fields the way they did in decades gone by. But the fact oil-rich nations are giving BP less access than they used to doesn’t change the fact that the world’s biggest oil fields are in decline, and new ones aren’t coming online nearly fast enough to pick up the slack. I can understand why OPEC doesn’t want to fess up to that reality, but why is Tony Hayward so reluctant?

Surely, these three factors of inflation, speculators, and lagging supply are the primary causes of rapidly rising prices. But, will any of these factors fall off or fade in the near future? Speculation is most likely to wain according to Hutchinson. Demand may well slump with consumer spending, but inflation will likely worsen… Bill Bonner says:

Talk is cheap. It’s action that is dear. And the action the Fed needs to take – raising rates – will be so potentially costly for the lame U.S. economy that Bernanke and Co. are afraid to do it. They’re hoping inflation will go away so they can continue the battle against the slump, without having to worry about their unprotected flanks. Most likely, they will make a gesture towards raising rates – perhaps a quarter of a point. But then, when the mob starts howling for his head, Ben Bernanke will drop them again.

It’s evident that the Fed does not have the will or the tools to ward-off looming inflation. With inflation eating your dollars and commodities most likely set to rise higher, there are still many opportunities to profit…

Implications

Martin Hutchinson says:

Investing in the late stages of a bubble is highly speculative. Nevertheless, I reiterate my prediction of a few months ago that gold will reach $1,500 an ounce. Even if the Fed begins to act against inflation in August, it is very unlikely that its initial actions will be effective. Don’t forget that in the last great inflationary bubble of 1980, gold hit a level that’s the equivalent of $2,300 an ounce in today’s money.

I would consider SPDR Gold Trust (formerly StreetTracks Gold Trust) shares (GLD) about the most efficient way of getting a pure gold play. As an alternative, you might consider a silver investment: The metal is currently trading at less than 15% of its 1980 high, the equivalent of $130 per ounce. If that’s a move you like, the iShares Silver Trust ETF (SLV) seems the best way to play silver directly.

Also see other commodity ETFs such as:

S&P GSCI(TM) Commodity Indexed Trust (GSG)

PowerShares DB Agriculture (DBA)

Market Vectors Global Agribusiness (MOO)

But they were wrong. The Datastream Internet Index reached its peak on January 3, 2000, and then collapsed, falling 93.8% over the next 34 months.

In 2005, investors thought the real estate market was “different.” Homeowners were buying houses more expensive than they could afford because they thought inflation would protect them. While home prices could stagnate, they wouldn’t go down.

But, as you know, they were wrong. Beginning July 2006, real estate has fallen 16.2%.

Investors will come up with any excuse to continue pumping money into a sector that’s produced amazing returns for them in the past. And when the money starts piling in, it’s time for you to get out.

Today, the sector is oil. In inflation-adjusted terms, the price of oil is up 140% in the last 18 months. At first glance, the logic seems plausible…

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Global demand for oil is surging. Most of this increase comes from emerging economies like China and India. And global oil supply is on the decline. A large cause is poor reserve management by nationalized oil companies.

Venezuela’s oil production, for example, decreased by at least 1 million barrels per day (bpd) since President Hugo Chavez nationalized the country’s oil fields between mid-2006 and 2007. And Iran’s leaders can’t attract private capital and technology, so production is down 3 million bpd to half of what it used to be under the Shah.

Russia and Nigeria are in the same boat… The problem is, high oil prices make governments greedy. They take over oil fields and mismanage them, decreasing supply growth… and leading to even higher oil prices.

This imbalance has catapulted the price of oil to stratospheric levels. Even when adjusted for inflation, the price of crude oil is now far above its 1980 peak.

In the long run, simple economics tells us the price of a barrel of oil should equal the cost of producing the most expensive barrel of oil needed to meet global demand.

According to the Energy Information Administration (EIA), the oil market has a small surplus of existing production. And according to a Dallas Federal Reserve economist, the most expensive barrel of oil needed to meet global demand is being produced at just $50. With oil currently priced at $137 a barrel, the incentive to find and produce more oil is enormous.

This process takes time… But there are already signs supply is climbing. Shale oil in the Dakotas and in the Canadian tar sands – which costs about $70 a barrel to produce in both places – is attracting enormous amounts of investment capital.

In addition, research into the process of converting coal to oil might yield a more environmentally friendly process sometime in the near future, which would overcome one of the major hurdles facing coal-to-oil production now. The supply of coal in the U.S., if you were wondering, is plentiful.

From the demand side, the EIA reports consumption in 30 developed countries has fallen 460,000 bpd since last year. Most of that decline comes from plummeting U.S. demand.

This commodity rally – and the oil boom in particular – is not any different than previous booms. The market will find a new equilibrium, and the price of oil will undergo a nasty correction.

Good investing,

Ian

P.S. As my colleague Matt Badiali explained in a recent DailyWealth essay, don’t confuse brains with a bull market. If you own oil and gas stocks, now’s the time to keep an eye on your stops. On the other hand, the market has mauled refiners. But I think right now, refining stocks are perfectly positioned for the coming oil rout.

Source:  Why Oil May Be Headed for $50