How to Make a Lot of Money Trading Oil This Summer
By Jeff Clark
June 17, 2008
Poor Ian Davis has no idea what he just did.
Ian is the resident quantitative analyst at S&A Research, which publishes Growth Stock Wire. In yesterday's issue, he badmouthed oil. "It's not different this time," Ian wrote as he compared the recent action in oil to the peak in Internet stocks in 2000 and housing stocks in 2005. "Oil may be headed to $50."
Ian's view will, no doubt, create controversy among our legions of readers. Oil investments are popular right now – perhaps as popular as they have ever been. So being bearish on oil is an invitation to hate-filled e-mails.
But the thing is... Ian is right.
Oil and oil stocks are cyclical – just like every other investment. There's a good time to buy into the sector and a bad time to buy. In Ian's view, and my view, now is a bad time to buy oil.
In fact, the situation reminds me of a story I recently shared with my Advanced Income subscribers...
It was 1986. Oil was trading at $10 per barrel. And Dave, a salesman for an oil and gas limited partnership, invited me and five of my top stockbrokers to lunch.
We traded stocks and options, so we had no desire to spend time listening to a pitch about limited partnerships. But Dave was persuasive... "Please," he pleaded, "I just have to prove to my boss that I actually talked to you. I'll take you to the best restaurant in town. You can order anything you like. And the drinks are on me."
I'm not sure if it was pity, hunger, or the chance at free booze that motivated us. But 20 minutes later, we were in a private room at the best Italian restaurant in Oakland, and Dave was telling us about the oil business.
"This is the toughest year of my career," Dave said. "Nobody wants to buy oil. Of course, it wasn't always like this. I remember holding seminars back in the 70s – during the peak of the oil and gas crisis. We didn't even have to present our product. All we had to do was tell the crowd, which was always standing room only, we were going to invest their money in oil-producing properties. And the money would pour in. They couldn't write the checks fast enough."
"But not today," he continued. "I can't get anyone to listen to me. It's the best story in town, but everyone thinks oil is worthless. I promise you, though, it's not. And here's why..."
Then Dave stood up from the table and pulled a small birthday candle out of his pocket. He lit the candle, held it above his head, and said, "This was the oil market in the late 1950s and early 1960s. The nation's economy was robust and expanding. And oil was in high demand. Everyone wanted to invest in oil."
He blew out the candle and said, "This was the oil market in the late 1960s and early 1970s. All of the investment from the previous years created a glut in supply. The nation's economy was slowing, and demand for oil slowed right along with it. Oil prices fell. Investment dried up. And oil was given up for dead.
"And then came the oil crisis of the 1970s, and demand for oil grew stronger than ever." As Dave spoke, the candle began to flicker and the extinguished flame was re-lit. "Once again, investment in oil and gas exploded. Everyone wanted in on the deal. By 1981, oil was over $40 per barrel."
Dave blew out the candle one more time. "But all that new investment created a glut in supply. And once again, prices declined."
He pointed at the extinguished candle and said, "Here is where we are today. It's dark and there's nothing exciting going on in the oil market. No one wants to invest."
The candle started to flicker and the flame quickly reappeared. "This," Dave continued, "is where oil will be tomorrow. The best time to invest is when all the other investors are in the dark."
It was the best illustration of contrarian investing I had ever seen.
Right now the oil candle is burning bright. Maybe, just maybe, the smart trade today is to buy into sectors that will profit as oil declines just a bit.
Best regards and good trading,
Jeff Clark
