Close to an Oil Top? Not Even Close
by Tom Dyson
October 31, 2006
My family decided to take a long road trip in 1979.
We were going to drive from Atlanta, across Texas, turn south into central Mexico, and then hug the Gulf coastline all the way back to Georgia.
Before setting off, my dad loaded two metal gas cans into the back of our blue Chevrolet station wagon. I had seen the lines at the gas stations and heard all the news stories, so I knew what they were for. It just surprised me. I knew how much my dad hated carrying gas in the car.
That summer, oil had risen from $15 to almost $40. Investors were hysterical over inflation. Workers went on strike. Newspapers called for the government to nationalize Big Oil. Wall Street was certain a barrel of oil would rise to $100. Recession loomed over everyone’s neck like a guillotine. And of course...
Drivers all over the country had problems finding gas.
It is true that demand for oil outstripped supply for a short time in the late ’70s. But didn’t anybody notice all the new drilling rigs popping up?
Thousands of young people started taking geology in college, and oil engineering appeared on the list of high-paying careers. Billions of dollars went into looking for oil in the North Sea and the Gulf of Mexico. Dad turned down the thermostat, Mum wanted a Japanese car, and I wore thicker sweaters to school.
If there are 500 deluxe condos for sale in Miami and 2,000 baby boomers poised to buy, prices will rise. But if the stock market crashes, and now there are only 250 boomers waiting to buy, prices will fall.
It’s the same way in the oil market. While my dad was piling gas cans in the back of his Chevrolet, the oil industry was doing the same thing… building up inventory and stockpiling production. By the mid-1980s, supply was far greater than demand, and oil fell from $40 to $30 and then down to $10 by 1986.
Which brings us to today’s situation...
On January 1, 1999, you could have bought crude oil for less than $11 a barrel. You could still have bought less than $18 in November 2001.
Today, it’s around $60 a barrel, having been as high as $77. The huge run-up is throwing off many of the same patterns we saw in the 1970s. There’s talk of massive inventories here in America. The Energy Information Administration said yesterday that crude stocks are “well above the average range for this time of year.”
I also see China has started to fill the Zhenhai Strategic Petroleum Reserve Base, which has the capacity to hold about 33 million barrels.
And everyone’s talking about alternative fuels like ethanol and wind energy. Even fuel-efficient cars have started to sell.
A contrarian investor – sensing all this hype – might be tempted to call the top of the market. I’ve nearly fallen into this trap several times.
But I won’t do it. I don’t think we’re even close to the top of the market yet.
For one, there haven’t been any lines at the gas stations. My dad doesn’t take spare gas cans on his long journeys, and all my neighbors still drive SUVs to work. No one’s really hurting. Even the stock market shrugged it off. The S&P is up 10% since oil began its advance in 1999.
More importantly, the 20% drop in oil over the last couple of months has totally changed sentiment. This is the clincher for me. Near a true bull-market peak, it seems absolutely inconceivable that prices could fall. But when everyone starts predicting a return to the bear market after a measly 20% correction, I know we’re not even close.
How do I know there are still so many skeptics out there?
The recent Commitment of Traders report is one signal. This weekly survey of futures traders shows the hedge funds and money managers – known as the “large specs” – have cut back from an all-time long position to a short position in less than two months.
But more importantly, the feeling I get from conversations with neighbors and friends is that they think the storm has passed and we’re back on the road to cheap gas again. Apathy isn’t found at the top of the market.
When oil hits $100, I’ll reconsider. Until then, I’m buying.
Good investing,
Tom
P.S. Oil company execs are no better than the general public at predicting oil prices. They may even be worse.
In 1971, the world’s most famous contrarian investor, Jim Rogers, went to visit a Tulsa drilling-rig company. Jim was bullish on oil and he was looking for a safe way to buy into the industry. A drilling-rig manufacturer seemed like the perfect play.
“Oh lord, Jim,” said the chairman. “I know I shouldn’t say this, since we need all the support we can get, but you seem like a nice young fellow, even if you are from New York. Don’t buy our stock. It would be a big mistake. If only I weren’t 55 years old but 28, I’d get out of this business in a minute. I’d start over in anything rather than oil. Drilling is a dying business.”
Editor's note: Tom Dyson is a regular contributor to DailyWealth, a free investment newsletter focused on the world's best contrarian opportunities. We write with a simple belief in mind: You don't have to take big risks to make big money with your investments.
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