This Is Grandma's Oil Market Now

by | published January 22nd, 2010

Investors are well advised to take advice from a couple of grandmothers, especially when it comes to the oil market.

Keith Fitz-Gerald, the Chief Investment Strategist of Money Map Press and my colleague over at Money Morning, has just released an engaging book called Fiscal Hangover. Among a number of other interesting elements, its pages introduce the reader to his grandmother, Mimi. She was Keith's first investment and market mentor.

As fate would have it, I also had a grandmother named Mimi.

Mine was a gruff, cigar-smoking rock of a woman who never met a politician she did not hate. She was always ready to embrace the newest conspiracy theory. And she remains the most down-to-earth person I have ever known – a trait that extended to her language and manners.

Keith's Mimi would advise him it is not how you diversify your money that matters, but how you concentrate it, especially internationally. My Mimi knew nothing of the financial world and had little formal education in anything else. But she did have one amazing ability: She could sense when things were changing well before anyone else.

You needed to avoid getting involved in any of her political arguments. But you were always smart to listen carefully if her sentence ever began, “There's something on its way.” This line was always followed by a shrewd observation – one that subsequent events would prove disturbingly accurate.

Over the past several days, developments in oil oblige that we seek direction from both grandmas. We need to concentrate on the global nature of the oil market. And we need to recognize the fact that it's on the eve a rapid transformation.

Not the Oil Market We Once Knew

The latest developments in oil are significant…

First, consider the recent run-up beyond $83 a barrel. According to analysts (you know, those recent MBAs with no experience and less common sense), there should have been “significant” resistance levels at $78 to $80. Yet the price tore through them like tissue paper.

Second, this is supposed to be the time of year when demand is at its lowest. Despite being in the throes of winter, and that the lingering financial crunch continues to withhold much of the traditional demand from wider areas of the economy, we have another oil pricing bubble forming fast.

Third, the icebox holding much of the country in its icy fingers has increased the usage of heating oil. Yet most of that volume is at lower prices contracted months ago. And in any event, this is refined product, not straight crude. The heating oil processed from $83-priced crude will not be flowing from refineries for weeks. The problem here is not the price of oil, but the availability of refinery capacity. And gasoline prices are increasing strongly during the time of year when nobody drives.

Crude oil is now more than 250% of the level reached at this time last year. Admittedly, a year ago the price was well below where a normal market would have set it. The credit freeze then had made even the trading of contracts problematic. And demand collapsed.

Today, however, we are witnessing the convergence of troubling supply levels and returning demand… in what is already an increasingly volatile environment.

Profiting from a Globally Induced Advance

The current dimensions are more acute than those leading up to the price spike in 2008. Yet the focus is becoming clear: This is a globally induced advance (Keith's “Mimi Principle”). Oil demand is returning quickly in China, India, East Asia, West Africa and Turkey, not in the U.S. or Europe.

Non-Western economies are driving the rising demand curve. The production is already located there, with the developed world increasingly dependent on reserves located in the Middle East.

Plus, new trading strategies and benchmarks are moving the trading balance out of New York City.

Meanwhile, the market that's forming is already departing from what we have come to know over the past five years. There is something new coming (Kent's “Mimi Principle”). Volatility in oil trading is increasing, while additional derivative issuances and credit swaps are now often required to provide the convergence of futures contracts and delivery pricing the market used to give as a matter of course.

Oil is now both a commodity and a financial asset, making it more susceptible to changes in currency values, holding strategies and broader market fluctuations.

I will be suggesting profit strategies here as we move into this “brave new world” of energy. Providing guidance on this journey is the primary reason I started writing these columns.

So stay tuned. And make no mistake…

The globalization of – and the changes in – this market will provide some of the most impressive opportunities for profit in our lifetimes. But this will also be a bumpy ride. It will require investors to prioritize new regions of the world… and to focus on a select group of production, field-service and delivery companies.

Both grandmothers would have accepted the challenge – Keith's Mimi because she enjoyed the market test; Kent's Mimi just to stick her thumb in somebody's eye.


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