Get ready to short the
oil stocks.
Last week, a newspaper headline told us that "OPEC Can't Stop Rising Prices." OPEC officials said that output increases can no longer suppress the rise in crude oil prices. Another read "Gas Shortage Rips Through Economy," followed by the opinion that the impact "could last for years." Natural gas futures prices soared 65% in one day. Many people think oil prices are going up forever. We see stories every day about oil shocks and oil inflation. But headlines like the ones above only appear when the party is nearly over. Like Wall Street's version of Buffy the Vampire Slayer, my job is to drive a stake through the hearts of momentum buyers before they strike again. Problem is, momentum buyers are a lot harder to destroy than vampires. To do so, you have to drive their net worth to zero. I thought we had killed them off when technology stocks collapsed, but they've popped up again, this time in the energy sector. Oil prices have gone up so sharply that a large group believes they'll keep going up forever. The Past Is Prologue We've heard all this before, of course. One of the advantages of age is you can remember previous times when we all got carried away with ourselves. Does any of this sound familiar? * In 1974, when Americans were standing in line for gas, and in 1980 after the second oil shock, there was no way to stop oil prices from going to $100 per barrel. * In 1981, there was no way to stop interest rates from going to 30%. Treasury bond yields hit 15% and CD rates hit 22%. Dr. Doom and Mr. Gloom told us that Americans would never save, and budget deficits as far as the eye could see would keep rates high forever. * In 1986, there was no way OPEC could stop falling oil prices. Oil was $6 per barrel. * In 1989 there was no way the U.S. could ever compete with Japan. The Japanese saved more. They worked harder. They sang company songs before work every morning. Analysts said Japanese earnings were different; their three-digit earnings multiples were cheap. The land under the Imperial Palace in Tokyo was worth more than the state of California. * In 1992, there was no way to stop collapsing real estate prices. Properties of bankrupt savings and loans were being sold by the container load, and land prices fell for four years in a row. * In 1999 there was no way to stop the Internet stocks. There was a new paradigm and a new economy. Profits were for tourists. Initial public offerings always went up. * In 2003, there's no way to stop oil prices from rising. The economy will never grow again. Companies will never make profits again, and investors will never buy stocks again. Are you beginning to see a pattern here? One-sided markets never last as long as momentum buyers would like. This one won't either. When it reverses, oil prices will revert to the levels that make sense for buyers and sellers, somewhere between $24 and $28 a barrel. More than 90% of variations in the revenues of companies in the energy sector are caused by changes in oil and gas prices. Momentum buyers caught when the price turns are going to get killed. The Long View Venezuelan strikes and the Iraq conflict are short-term supply issues that will be resolved in a matter of months. Once peace breaks out in the Persian Gulf, the cash needs of Gulf oil producers will be higher, not lower, than they were a year ago. Iraqi oil fields are likely to be in more stable hands than they have been for some time. Substantial investment capital will flow into the region to develop them further, as well as to rebuild the Iraqi economy. That adds up to more, not less, oil production and lower prices. Fundamentally, the volatility of oil prices is caused by the varying cash needs of oil owners -- OPEC countries and Russia -- on one hand, and the varying consumption levels of industrial countries on the other. Suppliers can't effectively sell oil without physically shipping it to a buyer. Buyers can't effectively buy oil for future delivery without physically importing and storing oil. All that could be changed if there were an efficient and trustworthy asset market for buying and selling claims on future oil. The chief impediment to this today is the lack of enforceable property rights and the lack of efficient capital markets in the oil producing countries. An Iraq war could change both.
Don't buy into the oil shortage headlines. Sometime soon oil prices
are going to turn and head south. Don't let them take your net worth
along them.
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