Calling the Bottom at $50 Oil

With oil, gold, commodities and stocks all falling, many investors are wondering where the bottom in these markets will be. I think we are very close. These assets cannot fall forever, even though it seems like there is no end in sight. There are incredible bargains out there already, but many of these assets (despite already being under valued) continue to fall. Holding cash (and in particular the US dollar) has been the best place to put money for the last few months, but I expect this to change very soon. Cash buys a lot more today that it did a few months ago since many investors exited their positions and ran into cash and bonds. This was in large part due to the spectacular rally in the US dollar, fueled by fears of deflation. My prediction is that when oil approaches $50 a barrel, the deflationary mindset will change to one of inflation. Investor sentiment can change on a dime and have profound and immediate effects. At one time, everyone thought buying sub-prime mortgages was the best thing since sliced bread, and another day, investors all tried to exit their positions in these toxic assets. Those who were unable to get out near the top quickly found the market to be illiquid and discovered that they could only receive pennies on the dollar for what was very recently a highly coveted asset.

Inflation will return with a vengeance and drive up commodities, oil and gold, followed even by nominal gains in stock markets around the world. People have been rushing into dollars for the past couple months, but I think this trend will reverse very soon and everyone will be running away from the dollar and other cash positions in a rush to own real assets.

I think the US dollar will find a top when oil falls to around $50. When this happens, OPEC countries will suffer significant pain since their revenue is totally dependent on high oil prices. Oil prices at these levels will virtually bankrupt many OPEC countries and most will no longer have the money to continue to buy US debt. In fact, OPEC countries will actually have to sell their dollar reserves in order to finance government expenditure as their oil revenues decline. As OPEC countries start selling their dollar reserves, the dollar will fall sharply and eventually collapse completely. I do not know how quickly the decline in the dollar will occur, but I suspect that the fall could be even faster than its recent assent.

Investors with cash on the sideline need to start making plans immediately to get rid of any US dollars and US dollar denominated assets they are holding. As oil drops below $60, investors should start spending their fiat currency (especially US dollars) on these undervalued assets. By the time oil drops below $55 everyone should be almost fully invested. And if oil falls to $50 or below, it is time to back the truck up. It is not certain that oil will fall to exactly $50 a barrel because it might only fall to $53, or go lower to $47, but I predict the bottom will occur somewhere around the $50 level. Therefore, I do not recommend that anyone try to time things exactly perfectly, or to buy in at the exact bottom. Investors who try to time the bottom perfectly may end up being too late and will be stuck trying to get rid of their dollars after the mindset has already changed. The important thing is to get out of dollars before the mindset changes from deflation to inflation, since it will be much more difficult to buy into hard assets at a time when there could be a run on the dollar.

There appears to be many traders who are also betting on $50 oil as oil options soared after the OPEC cut failed to support prices.

Bloomberg: Oil Options at $50 Soar After OPEC Cut Fails to Support Prices. October 24th, 2008.

What will ultimately push oil down close to $50? Just pick an event. It could be further weakness in stock markets or continued deterioration in the global economy. Anything that would continue to show slower global economic growth or deflation will continue to push prices down. An economic or political crisis may erupt that would suggest less demand for oil, pushing the price down. So even though I am pretty sure that oil will bottom around $50, it is not guaranteed that gold will be dragged down also. Depending on what event pushes oil lower, gold may rise as oil falls. A crisis that would push oil lower could simultaneous push gold higher since gold traditionally rises in a crisis situation. The gold market is also very small and there is a lot of demand, therefore it is possible we have already seen the bottom in gold. There is so much demand for gold that all the buying should support prices to some degree. Gold could act as the canary in the coal mine as prices may rise in anticipation of what is to come and start blazing a trail that other commodities will eventually follow. Stock markets will probably bottom when oil reaches $50, whereas this is not necessarily the case for gold. When investors put their cash to work, they should first buy gold, then silver, then foreign stocks, and then oil. Investors not already holding gold should purchase some immediately, and then enter the stock markets as oil falls below $60, and finally the oil sector when oil falls below $55. Then sit back, buckle your seat belts, and prepare for a bumpy ride.

Investors should load up on physical gold and silver, (and maybe platinum and palladium as well), gold mining stocks, oil and oil sector stocks, agriculture, other commodities and foreign currencies. The large gold mining stocks will be the first to move up, followed by spectacular moves up in junior gold miners with defined deposits as money rushes into the ground. Foreign stocks in Asia that trade at low P/E ratios and pay huge dividends are ideal. Stay away from any investment in the Middle East and focus on counties like Australia, Canada, Brazil, Russia, Indonesia or Norway for energy stocks. Oil stocks in a country like Australia may be preferable to oil stocks in Canada because Australia will be selling their oil to richer Asian counties whereas Canada sells most of their oil to poor Americans. With the low value of the Australian dollar, foreign investors should get a lot of bang for their buck with many of these Australian investments. I also think that agriculture stocks in New Zealand look very attractive because they provide exposure to the Asian markets while still being a modern industrialized western nation where investors may feel more comfortable.

To all of those who thought that the economic crisis got bad during September and October… you ain’t seen nothing yet. The events that have occurred in the last two months were not the crisis; they were the lead up to the real crisis. The real crisis begins when the dollar starts to fall, and this is a crisis that cannot be solved by the Federal Reserve and the Treasury printing up more money. The current actions that have been taken to postpone the crisis will soon accelerate the crisis if policy remains unchanged. With everyone in the media talking about deflation, the inflation will take everyone by surprise causing a mass exodus from the US dollar and into traditional inflation hedges like gold and commodities.