Three Reasons to Believe in $100 Oil
As an investor, this volatility can be difficult to handle. Throw in the uncertainty of today’s geopolitical environment, and investors feel the need to downsize their positions in commodity investments, such as oil.
We think markets could remain volatile in the short-term, but here are three long-term indicators to support $100+ per barrel oil prices.
1) Long-Term U.S. Dollar Weakness
The U.S. dollar was up over 1 percent again last week and has increased nearly 4 percent since hitting a 52-week low on April 29. On a five-day rate of change, the dollar is up about 1 standard deviation.
As I said last week, this move is less about the vigor of the U.S. dollar and more about the relative weakness of the eurozone and other fledgling countries. In addition, it’s likely we’ll continue to see relative strength in the U.S. dollar as we get closer to the end of the Federal Reserve’s QE2 program, set to wind down in June.
We think these are short-term drivers and don’t accurately reflect the long-term headwinds facing the dollar. I’ve discussed these often and in an attempt to keep this note brief, I’ll let the following picture tell the story.
This snapshot from USdebtclock.org (taken late in the afternoon on May 13) shows the precarious fiscal and monetary situation of the U.S. As you can see, the overwhelming color is red. Even if Washington decided on a comprehensive plan to fix entitlement overspending, trim defense spending and reduce the U.S. deficit today, it would take years to see any meaningful shift in these figures.
Therefore, we feel the recent uptrend in the U.S. dollar is a short-term reprieve from a long-term downtrend.
2) Demand from Emerging Markets Outpacing Developed Market Demand
Last week, the Paris-based International Energy Agency (IEA) and the U.S. Department of Energy both communicated softness in global oil demand. The IEA noted that preliminary March data shows the first “marked slowdown” in annual growth for the first time since 2009. The IEA is forecasting growth of 1.3 million barrels per day in demand for crude oil in 2011, down from 2.8 million barrels per day in 2010.
In the years since, China’s crude oil imports have increased more than 260 percent despite per barrel oil prices jumping nearly four-fold. This is indicative of the insatiable demand that emerging markets have for oil.
3) Majority of Global Oil Reserves Located in Geopolitically Unstable Regions
In the April 11 update “Why High Oil Prices Are Likely Here to Stay,” we highlighted how a large portion of the world’s proven oil reserves and production comes from unstable countries and regions, including Nigeria, Venezuela, Iraq, Iran and Libya. According to some estimates, as much as 80 percent of the world’s oil reserves lie beneath these shaky regions.
Civil wars and attacks on oil facilities can create production slowdowns or even shut down production entirely. The conflict in Libya and unrest in several other Middle East countries shows just how quickly this can affect global oil markets. Iraq is another example of the difficulties inherent in production expansion in these regions. Last week, the country’s former oil minister said it would only be able to meet half of its stated production goal by 2017. The original forecast, clearly a lofty one, called for roughly 12 million barrels per day in oil production.
Over the years, the proximity of oil reserves to unrest has led to a reduction in global spare capacity or the excess amount of oil that can be produced, if desired, to meet demand. When the turmoil broke out in Libya, the general consensus was that Saudi Arabia’s spare capacity would be more than enough to meet market demand. That hasn’t been the case as Saudi Arabia has moved to calm its own population to prevent unrest.
The result is little wiggle room to meet demand should we experience a boom in demand or an event disrupting production. In general, these supply/demand dynamics support historically high prices.
Frank Holmes is CEO and chief investment officer of U.S. Global Investors, Inc., a boutique investment advisory firm based in San Antonio that manages domestic and offshore funds specializing in the natural resources and emerging markets sectors. The company’s no-load mutual funds include the Global Resources Fund (ticker PSPFX), which invests primarily in energy-related stocks.
For more insights and perspectives from Frank Holmes, visit his investment blog “Frank Talk” at http://www.usfunds.com/investor-resources/frank-talk/.
All opinions expressed and data provided are subject to change without notice. Some of these opinions may not be appropriate to every investor. Standard deviation is a measure of the dispersion of a set of data from its mean. The more spread apart the data, the higher the deviation. Standard deviation is also known as historical volatility.
Please consider carefully a fund’s investment objectives, risks, charges and expenses. For this and other important information, obtain a fund prospectus by clicking here or by calling 1-800-US-FUNDS (1-800-873-8637). Read it carefully before investing. Distributed by U.S. Global Brokerage, Inc. With respect to the money market funds, an investment in a money market fund is neither insured nor guaranteed by the Federal Deposit Insurance Corporation or any other government agency. Although money market funds seek to preserve the value of your investment at $1.00 per share, it is possible to lose money by investing in these funds.
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January 19th, 2020
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