Is This Toxic To The U.S. Economy?
The Dynamic Wealth Report
April 21, 2010
by Justin Bennett, Editor
In recent weeks, I’ve been discussing the oil market. I’ve been talking
about peak oil theory and its potential impact.
I’ve also been pointing out the short term bearish fundamentals for oil. Strangely enough, the market is ignoring the fundamentals. Oil recently
hit a 52-week high of just over $87 a barrel.
I believe current prices are higher than fundamentals warrant because
of excessive speculation on the part of large institutions.
I voiced my opinion and many of you did too…
It seems like quite a few readers are watching the oil markets as well. I received feedback from a number of readers.
For example, Frederic asked:
… Now what do we do? I have traded oil and gold for last 2 years, doing
very well... But the future is "dodgy"... as they say in the UK. So... how can we do this???? Regards…
I cut back some of his email as you can see, but you get the point.
First of all, let me say this… Crude oil is the most important market in
the world.
Why do I say it’s the most important market?
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Because, the oil market directly affects average citizens. The price of
oil and its end products like gasoline, diesel, and heating oil, hit
consumers right in the pocketbook.
Stock prices, as well as other commodity prices, are important. But their
daily price swings do not affect the average person directly. Millions
of people have nothing to do with the stock or commodities market. Yet
the oil market and the price resulting from it… well, it affects
everybody in a developed economy.
Consumers and producers alike are affected by the price of oil. The
effect of oil on the world economy is inescapable.
Now, I won’t kid you by saying I’ve got it all figured out. The crude
oil market is incredibly complex. So here’s my one and only takeaway for
oil prices.
In my opinion, when oil gets over $100 a barrel, it’s toxic to the U.S.
economy…
When oil prices are rising, more and more discretionary income is put
towards purchasing energy. Money consumers could be using to buy goods
is instead spent on energy. And as you know, we live in a consumer based
economy.
The current U.S. unemployment rate is at 9.7%. Oil won’t have to reach
the 2008 highs of $147 to have an extremely negative effect on the
economy. I suspect any price much over $100 will bring the U.S. economic
recovery to a screeching halt.
That’s why the recent rally in crude doesn’t make sense…
The current fundamentals don’t warrant $87 oil. The higher speculators
push it, the more harm it does to the economic recovery.
Personally, I don’t like to trade the oil market. I think excess
speculation in this commodity is self defeating for everybody. The
higher the price goes, the bigger the drag on the economy.
So what’s my trade for rising oil prices?
Short oil when it gets to an unsustainable price…
This was one of the best trades of 2008. Oil was trading at $147 a
barrel. As the economy faltered and the worldwide recession began, crude
prices fell off a cliff.
One way to short oil is to buy put options in oil based ETFs such as U.S. Oil Fund (USO). As crude plunged below the $40 level in late 2008,
put holders made a killing.
This trade paid off handsomely when the last oil bubble popped. I
suspect the exact same thing will happen the next time oil gets up to
nosebleed levels (over $130).
You see, a phenomena known as demand destruction takes care of high oil
prices. When oil becomes unaffordable, the end demand crumbles. And soon
after, the price will follow as excess supply hits the market.
That’s how a price rationing system works…
Only those willing and able to buy a commodity can do so. When a large
portion of society can’t afford it… demand destruction brings the price
down.
I think oil will plunge again when the price becomes unsustainable. But
unfortunately, our economy will come down right along with it.
• Silver (Over $17 an ounce)
Silver has surged over 20% off the February 2010 lows. As world
economies continue to recover, industrial silver demand will grow. Silver is widely used in modern electronics due to its high
conductivity.
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