A non-conspiratorial explanation of oil's price history

As you're probably aware, oil this year surged to $147 a barrel and then fell to, as of today, about $40 -- over a 2/3 drop in less than six months. And its peak was over a 100% increase from the previous year. With a lot of the decline shortly before the election, this roller-coaster ride has prompted quite a lot of conspiracy theories.

Well, recently on another (private) forum, I summarized the significant reasons why oil acted like that, without reference to any conspiracy. I'll repeat it here:

1) China was buying a lot of oil and stockpiling it. Unlike the general "growth in emerging markets", this actually came as a surprise to a lot of speculators, which is why it was such a fast rise instead of a gradual one since 2000. China was doing this in order to burn less coal and make the air cleaner for the Olympics. Now that that's over, a significant source of demand is gone.

2) Because of the credit crunch, speculators were significantly less able to borrow and bid up the price of oil. Once it hit, they had to significantly unwind their positions.

(Now, I'm all for the right of people to make speculative purchases; however, what we had there was *far* from a free market. For one thing, the government's bailing out of banks that had hedge funds doing the speculating, eliminated the strong negative downside to hype-based, stupid speculation. Also, a lot of the *naked* shorts and longs were very corrupt where if one party lost money, the brokerage would act like it can't find the original contract and try to reverse the sale. Things like this artificially amplified the price premium due to hype [as opposed to rational estimations of future developments] and crowded out wiser investors.)

3) The global economic downturn significantly revised investors' estimates of future oil demand.

4) The president's, and then congress's, termination of the ban on offshore drilling also significantly changed expectations about future oil availability. These helped prod oil down.

Profit opportunities for Silas: oil and GM

Back to the two most frequently discussed topics on this blog.

First, let's talk about oil. Though by the end of the day, this may change, the spot price temporarily went below $120. Time to strike when the iron is hot? If I bought the double-oil-return ETF discussed last week (DXO), and it were to return to its previous high, that would be a nice 46% return. (Btw, y'all oil options traders are accurately factoring oil's massive volatility into the implied volatility term in your options pricing, right? Okay, just checking.)

Second, let's talk about GM. I have been claiming, since studying GM's history back in '05, that a bankruptcy was near, and so my brother and I have been discussing an even odds bet that would pay off if bankruptcy happened, or some other even of equivalent lameness, such as: defaulting on any bond, PBGC takeover of legacy obligations, refusal to pay legacy obligations, or government bailout. I'm not sure if we ever agreed to a bet value and a time frame, but a few weeks ago I emailed my brother some news about GM, and he reiterated his position that there would be no bankruptcy, so if we haven't agreed to something, I could still get an even odds bet in.

While I did post some news about GM's lameness last Friday, I have some more. Here's a Reuter's article detailing GM's rising defaulting insurance premiums and falling bond prices. Right now, you must pay 47% of the amount insured, so $47 to insure $100 of debt. And you know what? Most people, facing that much to insure something, just don't buy it, and bear the risk themselves. Heck, that's what hospitals do for their liability insurance, which can get that high.

It also lists the prices of GM bonds, but strangely, Reuters prefers to list the cents on the dollar (click on "first vlog post") price, and never the yields, neither the current yield, nor the yield to maturiy. But my own calculations give about 12% current yields for short term bonds and 18% for long term bonds based on the numbers there

But strangely, the prices of GM bonds that I found on my Scottrade account gave a different story. (I can't seem to find a free no-hassle source for bond prices I can link.) I don't remember the current yield, but it listed GM bonds maturing in December of this year as trading with 9.3% yield-to-maturity, and bonds maturing in 2011 -- 3 years from now! -- as paying, and make sure you're sitting down, 29% YtM. Twenty-nine percent!!! There are banana republics right now that pay lower interest on their debt! There are reckless shoppers right now with lower credit card interest rates!

And to *double* the stakes on oil ...

Well, a little googling got me a blog post from Pacific Park Financial that lists leveraged oil ETFs, which they warn as being "not meant for buying-n-holding; rather, they are meant for making a calculated bet and exiting when you've reached your profit target or stop-loss." (emphasis mine)

A calculated bet? Oh, we can do that.

The one I'd be interested in here is DXO, which makes a leveraged long bet on oil, attempting to replicate 2x the gain/loss of oil. Unfortunately, it hasn't been around long (just over a month), but this chart, which I hope you can see okay, shows it neatly getting double the return on the security OIL.

If oil (no caps) merely returns to what it was three weeks ago, that's a nice 30% return for me. But of course, the whole point of the bet was that fate doesn't work like that, and my bad luck will thus drop oil's price even more forcefully.

Perhaps with a li'l work, I can find a different oil ETF that amplifies the return, but has a longer history. Or, switch gears entirely and try to use my luck to bring down an entire commodity index, rather than just oil.

Stay tuned. (archaic expression from they days of radio when they wanted you not to tune to a different station)

To invest in oil, invest in OIL

A reader who wished to remain anonymous suggested to me that if I want to go long on oil (so as to make its price collapse and end the suffering), I should take the route in plain sight: buy the ETF with ticker symbol OIL. Apparently, its value stays very close to 1.68 times the current spot price of oil. In fact, since neither Yahoo nor any of the finance sites I go to actually let you chart the history of the price of oil, you should use that chart when you want to compare something to oil's price history.

(The reason is that the quoted price of a barrel of oil is actually the price for a delivery in the near future, so expanding the time history of that just gets you the price of a briefly-traded security. But when you want the *history* of oil's price, you don't want a plot of the price of an "August 08 delivery"; you want a plot of "August 07 delivery as valued in July 07, September 07 delivery as valued in August 07 ...".)

Why you'd want to remain anonymous about that, I have no idea. :-/

How to invest in expensive oil?

While most of you still don't think it's a good idea, or will work as intended, for me to go long on oil in the hopes that my luck will bring prices down ... I still want to know the best way to do it in the case that I later decide that I want to.

First, the constraints:

I have a Scottrade (brokerage) account, which lets me buy stocks (including ETFs) and bonds. It is not, however, authorized to trade in options (or futures or forwards or shortselling), which would take a few weeks to authorize (I have to send in signed paperwork). So the first, question is, should I go ahead and authorize that, just to be ready?

As for money, the account has about $3200 in an ETF (ticker PRFZ) and under $100 in cash currently. I can add to it from cash reserves or liquidating other investments (including the PRFZ). You can safely assume I can buy $10,000 worth of securities.

Next, I would like to keep this simple, so I only want to invest in only one security -- so nothing like "buy this one and short this other ...". (It is of course acceptable to suggest a single security that *itself* employs such a strategy.) I want the best one stock whose returns track the standard quoted price of a barrel of oil, and yes, that means include any dividends, which makes it that harder to look up with the free investment tools available.

So, the question: which security to buy? An energy sector equity ETF? A natural resources sector equity ETF? A commodities index ETF? An ETF that employs some leveraged strategy that amplifies size of oil price movements? The bonds of an oil-rich developing country? Or, take the plunge and authorize buying calls on oil?

Suggestions are welcome!

Poll results: Don't go long on oil

Looks like the poll results are in. Wow, 9 votes, without me having to vote or arm-twisting people into vote, or voting myself!

One third of you (3) want me to go ahead with this, while two thirds (6) believe that the world doesn't work like I believe it does, in which fate conspires to work against me, such that I can exploit it to help others. (Surprisingly, none of you took the "High oil prices ROCK!" option, which is strange, since I mentioned the poll to the eminent David Zetland, and there's a contingent of people who see good in expensive oil.)

Well, the bigger the empire giant, the harder the fall. This will just make me that much more famous if I publicly declare intent to manipulate oil prices this way and I turn out to be right.

Pledges for gifts if I can make oil fall, can be made by email. Thanks in advance.

ADDENDUM: Some people are having trouble reading the poll options. They were:

-Yes! Full steam ahead! (3)
-No, high oil prices ROCK! (0)
-No ... the world doesn't work like that, kid. (6)
- ... Not even gonna dignify this one. No, wait! (0)

Should Silas hammer down oil prices?

If you haven't been living in a cave for the last six months, you've heard the big debate about whether we're in a speculative oil bubble. Whether the claims linked (which should guide you to a good discussion of the issue if you follow the links contained therein) are true, I will not comment on.

However, I do have good reason to believe that I have natural "bad luck". I won't get into any specifics, but I have been in the following scenario too many times to have kept count:

Helpful person: Oh, you want to accomplish X? Oh, just do Y, no problem.
Me: I did Y, and Z happened.
Helpful person: WTF????? That's supposed to be like a one in a million event!! That's just not supposed to happen, no no no, I refuse to believe that. That sure must have sucked if it did, but you must be making that up.

So, I was thinking ... should I channel this bad luck for the good of humanity? For example, all I'd have to do is take a good chunk of my portfolio, and use it to go long on oil (i.e. invest in such a way so that it increases in value if oil's price goes up and vice versa). Then, my bad luck attractor would cause oil's price to collapse.

Pros: End pain on the billions of people who buy oil-related products, including the people in countries suffering food riots.
Cons: Would cost me a few thou.

So far, not doing it looks like the more attractive option.

Now, there's a clear potential for pareto improvement here (I take paypal, thanks), but then, maybe creating an explicit contract with me to make up my investment losses would "tip off fate" and make the trick not work. So perhaps I need only vague, unofficial promises to treat me like a king for killing the oil monster? Share your thoughts.