The Best Way to Profit From $135 Oil
May 29th, 2008 | By Chris Mayer | Category: Oil Investment & Alternative EnergyHas oil hit its peak price or not? The answer to that question leads us to ask whether or not commodities are a bubble about to burst. Barron’s recent cover story on commodities came down on the side that the party was over.
I believe the charts I have in this column contain some powerful insights. You will want to keep them handy when things get rocky. They come courtesy of Barry Bannister, an analyst at Stifel Nicolaus, who delivered an interesting talk in Baltimore recently.
I’ll focus on oil, though a similar story holds true throughout the commodity sector. I don’t put a lot of faith in macro predictions — as no one can predict the future. But you can study track records. You can look at history. History reveals some interesting clues about what the future may hold.
The quick take? It doesn’t look like the party is over just yet. But even if it is, past peaks in oil give us clues. When you dig a little deeper into those relationships, you find a great road map for making money.
If you look at the price of oil, you find something interesting. Since January 2001, you can explain the move in the price of oil largely as a function of increasing money supply. As the amount of money grows, the price of oil rises. In fact, almost 87% of the move in the price of oil can be explained by the increase in money supply, as this next chart shows:
Basically, $100 per barrel oil is what we would expect to see, given this relationship between the oil price and money supply. Given that we are still in the midst of a credit crisis of sorts, it seems unlikely the Fed will tighten money in any way at all. That leaves a clear path for the price of oil and commodities to continue to rally in nominal terms.
The other thing to remember — and people forget this by worrying excessively about a U.S. recession — is that the story of oil is no longer a U.S.-centric story. You’ve surely heard about how the rapid growth in China and other emerging markets drives oil demand. Well, it’s good to keep that in mind. See the chart below:
China and India are only beginning to consume oil at any meaningful level. Right now, they are consuming oil at a rate the U.S. did in the early years of the 20th century. But look, we don’t need China to start guzzling oil like we do. Even if it moves half the distance between it and Hong Kong, that’s a lot of extra demand. The way I look at it is this: What’s more likely, China stays at 1910 oil usage or moves somewhere closer to, say, 1950s U.S. oil usage? I think the latter.
Even if oil has already peaked, that doesn’t mean oil is headed back to $40 per barrel or lower. In fact, if this oil boom follows history at all, we’re looking at years of oil prices right around $100 per barrel.
After studying the history of other recent oil booms, what you learn is that in no prior oil boom did the price of oil retreat rapidly toward where it was before the boom began. In each case, the price of oil stayed up for years after the peak. If you’ve got investments tied to the booming oil prices, that means you’ve got plenty of years to make more money.
So where do you go to make that money?
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Chris Mayer is the editor of Capital and Crisis and Mayer's Special Situations. His contrarian essays have appeared on a number of websites and publications including the Mises Institute, the Freeman, GoldEagle.com, LewRockwell.com, FiendBear.com, PrudentBear.com and Individual Investor Magazine.
Chris that is great but still leaves me scratching my head.
Here’s my take.
Is gas expensive? No the value of the dollar we know is falling. But what is it’s true value or as Warren would say intrinsic value?
In 1980 a gallon of gas peaked at $1.30-1.40 a gallon. Take that value to this inflation calculator. http://www.westegg.com/inflation/infl.cgi
Enter the values , I entered 1.30, the result $3.67 for 2007. Pretty close
The same result for a gallon of milk- in 1929 (.45c)yields a 2007 price of $5.40 very close.
Now take the value of a barrel of oil in 1980 of $37.42 and in 2007 yields 105.42. Do the fed CPI figures look tampered with now?
Why can’t people afford gas? The inflation calculator has the answer.
Take the wage of a journeyman grocery clerk in 1970 which was $7.50
In 2007 he should be making $42 a hour to keep up with the price of gas.
Whoa he only makes $17.80 per hour. The fed is taking $200 per day from the clerk. Buys alot of gas doesn’t it? Now does the wage of a GM union member seem expensive? Nah it’s all in the dollar.
Regards Jim Quam
P.S. Here’s something interesting. Take the value of gas prior to the 70’s gas spike what I would call a baseline.In 1973 oil was $3.60 before it spiked higher into the 80’s . Enter that number into the inflation calculator and you come up with a non crisis price for oil of $17.66. Will it reach that price in a reaction? Don’t know.
While I don’t disagree with what you are saying, I think it’s a little unreasonable to postulate that a grocery store clerk made $7.50 anywhere in 1970. It’s only slightly less than a union apprentice machinist made in the same era, but this would seem to illustrate your point better.