Thinking About Buying Oil Low?

Written by Jason Simpkins
Posted January 14, 2015

Recently, a friend of mine – my best friend, actually – asked me about investing in oil. He wanted to buy now, while prices are low, in anticipation of a comeback.

Ultimately, he did, settling on the Energy Select Sector SPDR ETF (NYSE: XLE).

This is a fine thing to do, especially if prices keep falling lower. There are other ETF candidates out there, too.

Personally, I've been eyeing the ProShares Ultra DJ-UBS Crude Oil ETF (NYSE: UCO). It's leveraged so that whenever oil rebounds it'll deliver twice the return.

However, I haven't gone through with it yet, and I'll tell you why...

It seems many of us are taking an oil price rebound for granted. Indeed, oil's sudden and dramatic plummet has left many with the impression that prices will rebound just as suddenly and just as dramatically.

But that's not necessarily the case. The truth is, oil – and even energy and commodities prices, in general – could languish for years before they start rising again.

In fact, Saudi Prince Alwaleed bin Talal just told USA Today that we'll never see $100 oil again.

The reasons for this are simple.

First, there's the basic nature of supply and demand. Oil supplies are high and demand is low. That's not going to change much going forward. The global economy is gasping for breath after trillions of dollars in stimulus warped us out of the Great Recession.

With Europe stuck in a near-deflationary malaise and China slowing down, more stimulus could be on the way. But not on the scale previously seen and not in the United States.

The United States is actually going in the opposite direction, which is toward an interest rate hike. That rate hike may be token, and it may be delayed, but the Federal Reserve is insisting that it will come nonetheless.

So, too, will a stronger dollar – and that's bad news for commodities.

Over the past year, the Dollar Index – which measures the greenback against a basket of 10 currencies – has soared about 12.5%. Again, this is because the euro is being weighed down by the weakness of its bloc, while the Fed tapered, ended QE, and talked up its looming interest rate hike.

Dollar Index Jan 2015

This is the trend that's staring us right in the face right now, and it's not going away anytime soon. The path laid out before us is one that has steady, albeit slow growth, higher interest rates, and a stronger dollar.

That's it. In many ways getting the economy back to positive growth was the easy part. The hard part is going to be normalizing it. Eventually, we're going to have mop up all the liquidity that flooded the market. That's going to be long, sluggish process. And it was that liquidity that artifically-accelerated growth that pushed oil prices so high in the first place.

Now, as far as oil production is concerned, we could see less growth there. But at least for the moment, production is still rising. Not as sharply as it has over the past few years, but it's growing nonetheless.

That will change as prices slump. We'll continue to see more costly oil production projects abandoned and put on hold. But again, to what extent is unclear. Many shale oil producers are insisting they can remain profitable so long as oil is above $40 per barrel.

We'll see if that's true.

But for now, the dollar trend, the slow growth trend, and the supply trend – these are the forces that are winning. And I wouldn't rush to line up against them.

Don't get me wrong. I'm not saying oil is a bad bet over the long term. Like I said, I'm thinking about buying in myself, because I believe oil will ultimately rise. It just might not happen as soon as some of us would like.

Barring some wildly unexpected development, it could take years for oil to climb back to $70 or even $60 per barrel. And as Prince Alwaleed bin Talal said, we may never see $100 oil again.

So if you want to buy low, buy low. Just be ready to wait. Also, if you buy now, and oil prices keep falling, don't abandon your position. Double down on it and lower your costs.

In the meantime, you might consider investing in some industries that benefit from low oil prices. Airlines and chemical companies, for instance. A lot of these industries suffered when oil was high. Now, their stock is cheap, and so are their input costs. Their earnings are going to look a lot sunnier from here on out.

Fight on,

Jason Simpkins Signature

Jason Simpkins

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Jason Simpkins is Assistant Managing Editor of the Outsider Club and Investment Director of The Wealth Warrior, a financial advisory focused on security companies and defense contractors. For more on Jason, check out his editor's page. 

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