I am not an economist but I believe oil prices have risen beyond where the market should set the price. Why? It is undeniable that increased demand, the diminished value of the dollar and world wide instability have played a real and causal roll in the rapid increase in prices, but I believe there are other forces at work. Allen Greenspan described it as irrational exuberance, but some might call it market manipulation, and some day in the future it might be called the oil bubble.
Basically oil prices went up due to the factors listed above and institutional investors, freshly stung by the credit crunch, saw it as a way to make easy money to fatten up their bottom lines. The theory is that if they can keep oil prices rising they can keep making money, then once the prices get high enough they can spread the risk and start cashing out. By the way this is likely true for most commodities right now.
This will go really well until the market blinks. Once people can no longer afford products made from oil, then the bubble will burst. Prices will readjust, and the paper wealth created by the bubble will evaporate. However, by then the big guy’s will have spread the risk, so the pain will be felt by all.
Basically, the impatience of my generation has caused people to stop seeing investing as a long term plan to ensure your money grows at a rate that significantly out paces inflation, into a get rich quick scheme. Unfortunately history has shown that the young and arrogant will be taught a painful lesson, from Icarus to the shoeshine boy buying stock on margin in 1929, it is a universal truth.
The upside is that I believe the green movement, which will be spurred by the price of oil more than by concern over the polar ice caps, will be what brings us out of the coming recession. I have previously posted on this topic so I will not go over it again. Also while hard times suck, they prune the weak and poorly run companies, which allows niche’s to reopen giving the strong ones to room to grow.
I promised I would tell you how to make money on the oil bubble. This isn’t a get rich quick scheme; this is more of a die rich scheme, so it only works if you can wait several years, so it helps to be young. The price of oil is crushing the stock market, which means many companies’ stock is at a bargain price. Look for companies that have a viable business model during the bad times, a global strategy and price under what the P/E ratio suggests. Yes, the prices will get worse, but over time the price will recover. However, you can’t sit on your butt, you have to watch the companies, since as they grow things change. They can become imbalanced, or lose their focus. For example AMF, was once an industrial giant, but it lost it’s focus and now they make the pin setting machines at bowling alleys. Conversely, Monsanto was a huge chemical company with an Ag division, now it is an Ag giant and very profitable.
As the oil bubble (or commodity bubble) gets close to popping, (you will likely see this in an imbalance between the price of oil (high) and the stock price of energy companies (low)), start looking for strong companies that have been hurt by high energy prices. Once margins improve these companies will recover quickly, which will help fill in your bottom line. Once the bubble is fully popped unless there is a war or something start looking at cashing out of the stocks they are getting hyped, and use the money to buy stocks in the energy companies that should be cash rich, but beaten by the drop in energy prices.
I know I have just described something that is a mix of a hedge fund and Warren Buffet, but it should work.
Don’t be afraid to look off shore (if you live in the US).
In the mean time enjoy $4.50 a gallon gas, or $5 if there is a hurricane.
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