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Crude Oil is a Better Bet than Stocks: Oil Prices Set to Spike?

By Jim Fink on February 15, 2012

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The Nasdaq Composite Index (Nasdaq: ^IXIC) rose to a more than 11-year high today before reversing (i.e., highest since February 6, 2001) and the S&P Small Cap 600 Index (Chicago Options: ^SML) hit an all-time high earlier in February. It’s extremely difficult to remain bearish when stocks are hitting multi-year new highs, as evidenced by technical analyst Louise Yamada’s reversal from bear to bull; she now believes that the Nasdaq has entered into a “new structural bull market.” Yamada is not as bullish on the Dow Jones Industrials (DJI: ^DJI) or the S&P 500 (SNP: ^GSPC), but all of these stock indices have high correlations with each other so the Nasdaq can’t go up much without pulling the other stock indices along for the ride.  

Most of the time, the stock market is a leading indicator which suggests that the U.S. may avoid a new recession despite ECRI’s call for one. The growth rate of ECRI’s weekly leading index (WLI) hit a 22-week high last week and, although still negative at -5.2%, is now less negative than the -5.5% reading at the height of the economic rebound in May 2008 before the stock market crash that followed. ECRI must be having doubts about its recession call. Even NYU Economics Professor Nouriel Roubini – known as “Dr. Doom” – thinks the stock-market rally will continue into midyear!

Keep in mind, however, that the S&P 500 and Dow Jones Industrials hit all-time highs on October 9, 2007 right before the Great Recession and bear market of 2008-09 got underway. No doubt about it: uncertainty continues to reign supreme.

U.S. Economic Outlook Remains Cloudy

The January employment report of 243,000 new non-farm jobs was very positive, showing the biggest gain since last April and the third-best monthly gain since 2006. Furthermore, the unemployment rate fell to 8.3 percent, the lowest rate in three years. According to Gallup, however, the employment picture has shown “deterioration” since mid-January so the good times may not last. Even Federal Reserve chairman Ben Bernanke recently testified before Congress that the job market isn’t as strong as the declining unemployment rate might suggest because it doesn’t include discouraged workers or part-time workers who would like a full-time job. In addition, consulting firm Challenger, Gray & Christmas announced that job cuts in January were up 28 percent, the largest increase since last September.

Lastly, the Congressional Budget Office (CBO) released its economic outlook for 2012 and 2013 and the news is not optimistic. The CBO warns that real GDP growth in 2013 is expected to decelerate to only 1.1 percent and the unemployment rate will rise to 9.2 percent if the Bush tax cuts, the payroll tax cut, and jobless benefits are allowed to expire.

Congress has apparently put aside its dysfunctional acrimony and reached agreement over how to extend the two-percentage-point payroll tax cut (affecting 160 million American workers) and unemployment benefits (affecting three million people), both of which are scheduled to expire at the end of February. That’s the good news. The bad news is that Fed Chairman Ben Bernanke recently told Congress that the scheduled expiration of the Bush tax cuts in December 2012 jeopardizes the economic recovery, as do the $1.2 trillion in automatic spending cuts scheduled to take effect in January 2013. 

Of course, none of this dour economic news has made a dent in the stock market rally which has been fueled by three years of unprecedented monetary easing and investor expectations that another round of quantitative easing (part 3) is a virtual certainty later this year. Investors may be bitterly disappointed, however, if Dallas Fed President Richard Fisher is right in calling QE3 a “fantasy of Wall Street.” Money supply growth has grown strongly in double-digits over the past year, which further supports additional stock buying. All of this monetary easing has caused BlackRock CEO Laurence Fink (no relation) to recommend that investors have 100% of their investable assets in equities.

Israel-Iran War Could Cause Oil Prices to Spike to $300 Per Barrel

The big wild card is the Middle East – particularly the chance of a war between Israel and Iran. According to investment newsletter veteran Richard Russell, the stock market would sell off big-time if a Mideast war unfolds:

I’ve been sensing something BIG and ominous is in the offing. What could it be? Ah, a front page article in Sunday’s NY Times supplies the answer. Israel will attack Iran with nuclear bombs. Israel must attack this year for this is the year when Iran will have nuclear capabilities.

Actually, the stock market is acting as though something momentous and frightening is ‘out there.’ The roof of a monster top is building.

Sounds a bit apocalyptic and I usually don’t reference such wackiness, but Russell has been publishing his Dow Theory Letters since 1957, is widely respected and by no means a crackpot, so his opinion is worth noting. Other crystal-ball gazers predicting a stock-market crash are John Hussman (also respected) and Joe Granville (no comment).

Intelligence analyst George Friedman of recently-hacked Stratfor places the odds of an Israeli strike at only 25%, but says that crude oil prices would skyrocket to $300 per barrel if it did occur. As I wrote in Best MLPs for $100 Oil, several energy-related master limited partnerships involved in exploration and production (E&P) as well as gathering and processing (G&P) are energy sensitive. Imagine how well they would do with $300 oil!

Best Crude Oil ETF

Of course, $300 oil would be a huge price shock that would likely ensure another economic recession, so even energy stocks could suffer if consumer demand were to fall as a result. The best “black swan” investment play may simply be a commodity bet on crude oil itself. I am aware of four exchange-traded products that track oil and I list them in descending order of average daily trading volume:

Most Heavily-Traded Crude Oil ETFs


Crude Oil ETFs and ETNs

Average Daily Trading Volume

United States Oil Fund (NYSE: USO)

10.4 million

IPath S&P GSCI Crude Oil Total Return Index ETN (NYSE: OIL)

599,000

PowerShares DB Oil Fund (NYSE: DBO)

454,000

United States 12-Month Oil Fund (NYSE: USL)

67,000

Source: Yahoo! Finance

Based on liquidity alone, the obvious choice is USO. But I wanted to dig deeper to see how these ETFs and ETNs actually performed. The differences in performance were striking:

Crude Oil ETF Relative Performance

 

Crude Oil ETFs and ETNs

Four-Year Performance:

Feb. 14, 2008 to Feb. 14, 2012

Bull-Market Performance:

Aug. 24, 2010 to Apr. 29, 2011

United States Oil Fund (NYSE: USO)

-48.7%

42.1%

IPath S&P GSCI Crude Oil Total Return Index ETN (NYSE: OIL)

-54.1%

45.6%

PowerShares DB Oil Fund (NYSE: DBO)

-14.7%

48.5%

United States 12-Month Oil Fund (NYSE: USL)

-18.1%

46.4%

Source: Bloomberg

Bull markets float all boats so I understand why bull-market performance among the four funds is pretty similar. Where the rubber meets the road is in bear markets, which the four-year performance reflects because of 2008. The two most heavily-traded oil funds performed worst over the past four years, which just goes to show you that popularity and excellence are often very different.

Bottom line: Confirming what I originally concluded in my November 2010 article entitled Crude Oil is Going to $100 a Barrel, the PowerShares DB Oil Fund (DBO) continues to be the clear winner among crude oil ETFs, having lost the least over the past four years and having gained the most during the mini-bull market between August 2010 and April 2011.


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