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The Secret Indicator That Points to Much Higher Crude Oil Prices

Commodities / Crude Oil Oct 06, 2010 - 06:48 AM GMT

By: Money_Morning

Commodities

Best Financial Markets Analysis ArticleKent Moors, Ph.D. writes: Crude oil has taken on a life of its own. As I have noted on several occasions, oil is both a commodity in wide demand and a financial asset in its own right.

In the former case, as a commodity, the so-called "wet" barrels (the actual oil) will respond to traditional marketplace pressures - particularly supply and demand.


In the asset role, which involves futures contracts (the "paper" barrels), oil becomes something that can be used as a store of value. As we'll see momentarily, oil's role as a financial asset underpins a crucial new development.

Six catalysts are behind the recent increase in oil prices. Five are well known in the marketplace. But it's the sixth catalyst - not as widely known or understood - that is central to our forecast that oil prices will continue their march.

This sixth catalyst also enabled us to uncover a significant opportunity for you to make a great deal of money.

Oil Price Catalysts to Watch
Three days hardly make a trend, but the spike in crude oil prices we witnessed last week is a harbinger of what I've predicted is on its way for "black gold."

U.S. stocks dropped last Wednesday and Thursday, but oil went in the opposite direction and moved higher. On Friday, both stocks and oil advanced at the open. But while stocks stabilized, oil kept right on marching.

Oil and stocks both fell on Monday - with the Dow Jones Industrial Average ending its worst day in nearly a month - after downgrades in several sectors boosted concerns about corporate earnings.

But then yesterday (Tuesday), oil and stocks both resumed their advances: Crude futures hit a two-month high and the Dow Jones Industrial Average posted a triple-digit gain, after a surprise rate cut by the Bank of Japan (BOJ).

Broadly speaking, investors believe that five factors are prompting the escalation in oil prices. Those factors consist of:

•Currency-exchange considerations.
•Oil inventories.
•Industrial performance as a measure of returning demand.
•Supply constrictions.
•And mergers and acquisitions (M&A).
To see how these catalysts work their way through the economy - and into the world's financial system - it's important to understand how they affect the price of oil.

First, virtually all worldwide oil sales are denominated in dollars. But the local sale of the products refined from the crude is not.

This catalyst has its greatest impact on oil in the interchange between the world's two dominant trading currencies - the U.S. dollar and the European euro. When the dollar's value (its "forex factor") declines relative to the euro, effective costs in dollars increase - as does the price of crude oil. And the reality is that the euro has been gaining significantly against the dollar of late.

Second, analysts were awaiting the Platts estimate yesterday and the U.S. Energy Information Administration (EIA) figures today (Wednesday) as a gauge of how much crude and processed oil products are in the market. High stockpiles translate into sluggish demand and have a restraining influence on prices. Lower stockpiles point toward increasing demand, concerns over shortages in oil products, and higher prices.

And right now, stockpiles are plunging.

Third, industrial-demand reports represent what investors in the current market environment usually regard as the "Holy Grail" of demand. Rising output signals an improving economy, more capital spending, and the greater usage of oil products. This is now falling into place.

Six of the 10 forward economic indicators are energy-intensive: When they rise, so does the need for oil. All six are in the green.

Do not try to gauge oil demand by looking at, for example, unemployment. That is a lagging indicator, meaning it's one of the last to change in a recovery. The market will move up appreciably before there will be any significant improvement in employment.

Fourth, as demand returns, questions surface over whether we have adequate supply to meet it again. As I have stated many times, once the recovery begins in earnest, the supply coming on-line will be hard-pressed to meet accelerating demand.

A recovery cannot take place without increasing uses of energy. And that translates into higher pressure on oil prices.

In the very-near-term evaluation of pricing, supply questions translate into constriction concerns. Are there bottlenecks in the upstream/downstream transfer of crude? Do we have refineries off-line or running at reduced capacity? Is weather a problem? Or are there earthquakes or floods? Are there tanker delays, pipeline explosions, cross-border problems in the Persian Gulf? Are technical glitches delaying volume from coming on-line at fields someplace in the world?

In a tight market, anything can cause prices to spike.

In my role as a TV commentator, I am often asked what the supply situation looks like. Back in the summer of 2008, when oil prices were at record highs, I once responded, half-seriously: "If a gasoline delivery truck this afternoon has an accident on the Garden State Parkway, it will have an effect on the NYMEX price."

Well, we are not there yet. But constriction problems are forming. Recurring hurricane concerns, a prolonged dock strike in France, and recent policy tightening by Beijing are only the latest.

Fifth, and finally, the M&A cycle in the oil sector is intensifying. A number of smaller producers are either being absorbed outright or brought into joint production activities with larger companies. In addition are major investment programs, such as last week's announcement that China's Sinopec Shanghai Petrochemical Co. (NYSE ADR: SHI) will invest more than $7 billion in the Brazilian unit of Spain's Repsol YPF SA (NYSE ADR: REP). Many of these moves will reduce competition, increase the oligopsony (when there are fewer first-stage buyers of crude), serve to concentrate profits, and increase prices.

All of these five factors are now either moving in the same direction (up), or are getting ready to do so.

For convenience, analysts use stock pricing as a proxy to determine where oil is likely to go. The assumption has been that the price movements in stocks will largely tell us what these five factors (and some others) are doing to the price of oil. In short, crude will follow swings in the equity markets. That seemed to make sense during the depths of the financial crisis and the accompanying lack of credit access.

Not any longer. We are coming out of the recession. And the most important element is actually one sitting just behind these five. While the first five factors are now recognized by the traditional approach to the market, the sixth is not. The actual engine of price increases as we move forward is a new development that most investors aren't even aware of.

It's called the "Ratcheting Effect."

The Secret Sixth Catalyst
As Oil & Energy Investor readers well know, my approach is to guide readers to high profits in the rapidly increasing volatility that is already making its way into the oil sector. That is not simply a result of overall developments in equity trading. A volatility index, for example, should show you the uncertainty in a market. That means as the index goes up (indicating rising uncertainty by traders), the market should go down, and vice versa.

Yet check out the Oil VIX for the past several weeks. It is exhibiting values that reflect the stock markets - not crude-oil prices. As the Oil VIX goes down, crude prices go up. As the Oil VIX goes up, crude prices go... up?!

At this point, you're no doubt thinking: "Say what?"

And that's been my point from the outset. When it comes to crude oil, we're dealing with a commodity that is widely required by world economies, and that also serves as a financial asset - so volatility acts differently. When we see the "perfect storm" in traditional factors - essentially what we've been witnessing over the past week - this underlying volatility assumes a life of its own.

I have even named this underlying factor: I call it the "ratcheting effect."

Just like the ratchet in your garage moves in one direction to allow greater leverage the other way, so, too, will the "ratcheting effect" increasingly bring about the same movements in oil pricing.

In depressed environments, that ratcheting effect will move prices down - and to a greater extent than the five "traditional" factors would justify. If you need proof, check out what happened between Sept. 1, 2008 and April1, 2009.

The same thing happens when we move in the other direction.

And that is where we are heading right now - and fast. The underlying volatility - the ratcheting effect - will increase prices more than the actual market factors would seem to justify. As a result, two things will happen:

•First, I will research, identify and spotlight specific market players that are well positioned and focused to benefit from this phenomenon.
•Second, investors who buy these stocks will end up making a great deal of money.
Stay tuned.

Action to Take: Follow the five widely tracked oil catalysts as part of your conventional investment research activities. But stay tuned to Kent Moors' research on the "ratcheting effect," as he identifies the oil-related companies poised to deliver the maximum level of profits to their shareholders.

[Editor's Note: Dr. Kent Moors, a regular contributor to Money Morning, is the editor of "The Oil & Energy Investor," a newsletter for individual investors. In a career that spans 31 years, Dr. Moors has been consulting the energy industry's biggest players, including six of the world's Top 10 oil companies and the leading natural gas producers throughout Russia, the Caspian Basin, the Persian Gulf and North Africa.

As the preceding interview so clearly illustrates, Dr. Moors' experiences - as well as the unrivaled industry access, contacts and insights he possesses - are the backbone of the Energy Advantage, an energy-sector advisory service that enables investors to capitalize on his contacts and his global-energy-sector insights. For more information on that service, please click here.]

Source : http://moneymorning.com/2010/10/06/oil-prices-22/

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