Is This Toxic To The U.S. Economy?

| April 21, 2010 | 0 Comments

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?

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.

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Category: Commodities

About the Author ()

Justin Bennett is the editor of Commodity ETF Alert, an investment advisory focused on profiting from the ebb and flow of important commodities via ETFs. The commodity veteran and options specialist is also a regular contributor to the Dynamic Wealth Report. Every week, Justin shares his thoughts with our readers on a variety of commodity-related topics. Justin is also a frequent contributor to Commodity Trading Research’s free daily e-letter. And he’s the editor of another highly successful and popular investment advisory, the Options Profit Pipeline.

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