The price of NYMEX Crude Oil futures just dropped $3.01 per barrel in a single day, reactivating the never-ending conversation about whether or not oil is a safe investment. I think it's worth our time to take a step back to review the roller-coaster that is oil prices.
Two years ago, on August 22nd 2007, the price per barrel of light sweel crude oil was $69.26. In just under a year's time, that price had more than doubled. By July 3rd 2008, oil was at $145.29 per barrel. That was the peak, after which oil dropped for 5 months, ending back down at $33.87 per barrel on December 19th 2008. Now, on august 14th 2009, it is back up at 67.51, just below the price it was in August of 2007.
So I ask: What part of the last few years' data is giving anyone the impression that oil prices are rational?
There is no reason that we should try to explain the price of oil in any traditional way. The laws of supply and demand are clearly not operating properly anymore. There are two possible ways to explain the volatility we've seen:
1. Oil futures trading has become such a speculative sport at this point that 'irrational exuberance' is running wild on the trading floors, making it impossible for oil to be priced anywhere near its intrinsic value.
or
2. During the last few years oil prices have fallen prey to a pack of extremely powerful instutitions (most likley hedge funds) that have coordinated to perpetuate this volatility streak for their own financial gain.
Two possibilities there, neither of which bode well for the average investor. Traditionally, when people ask if oil is a safe investment, the only way to logically answer affirmatively is if you're certain that oil demand will trend upward and/or oil supply will trend downward. (This is due to the fact that the intrinsic value of oil correlates positively with demand and negatively with supply.) But, I see no reason to think that oil prices are in any way connected to their intrinsic value any longer. So regardless of whether or not oil demand/supply will rise/fall, the price may not move predictably.
Oil may prove a profitable investment in the future, but it is anything but safe. I would reccomend the purchase of oil only to experienced traders (particularly short-term/range traders) and to traditional investors as a very small hedge/diversification play in their portfolio.
About the Author
Leslie Lewis Senior Market Analyst Lewis Financial Research Welcome to Lewis Financial Research Our mission: To provide all investors with unbiased, well supported, and thoroughly researched information.
Two years ago, on August 22nd 2007, the price per barrel of light sweel crude oil was $69.26. In just under a year's time, that price had more than doubled. By July 3rd 2008, oil was at $145.29 per barrel. That was the peak, after which oil dropped for 5 months, ending back down at $33.87 per barrel on December 19th 2008. Now, on august 14th 2009, it is back up at 67.51, just below the price it was in August of 2007.
So I ask: What part of the last few years' data is giving anyone the impression that oil prices are rational?
There is no reason that we should try to explain the price of oil in any traditional way. The laws of supply and demand are clearly not operating properly anymore. There are two possible ways to explain the volatility we've seen:
1. Oil futures trading has become such a speculative sport at this point that 'irrational exuberance' is running wild on the trading floors, making it impossible for oil to be priced anywhere near its intrinsic value.
or
2. During the last few years oil prices have fallen prey to a pack of extremely powerful instutitions (most likley hedge funds) that have coordinated to perpetuate this volatility streak for their own financial gain.
Two possibilities there, neither of which bode well for the average investor. Traditionally, when people ask if oil is a safe investment, the only way to logically answer affirmatively is if you're certain that oil demand will trend upward and/or oil supply will trend downward. (This is due to the fact that the intrinsic value of oil correlates positively with demand and negatively with supply.) But, I see no reason to think that oil prices are in any way connected to their intrinsic value any longer. So regardless of whether or not oil demand/supply will rise/fall, the price may not move predictably.
Oil may prove a profitable investment in the future, but it is anything but safe. I would reccomend the purchase of oil only to experienced traders (particularly short-term/range traders) and to traditional investors as a very small hedge/diversification play in their portfolio.
About the Author
Leslie Lewis Senior Market Analyst Lewis Financial Research Welcome to Lewis Financial Research Our mission: To provide all investors with unbiased, well supported, and thoroughly researched information.