Corn prices recently surged to more than $6 per bushel, up by more than a third since the beginning of the year. Meanwhile, financial news outlets continue to focus on gold’s incredible ascent to all-time highs over $1,400 an ounce.

But crude oil, the erstwhile leader of the commodity pack, has lagged and is less than 10 percent higher than it was in early January. Oil has marched in place for a number of reasons, including overblown fears of a double-dip recession in the US and bloated inventories across the developed world.

That’s changing. Oil is finally on the move and reached a new 2010 high in early November. This rally is supported by fast-improving fundamentals. Crude is set to play catch up with other commodities, and I expect oil to top $100 per barrel by late this year or early in 2011. For the next six to 12 months, oil-levered plays are among my favorite stocks in the energy space.

Here’s a rundown of eight reasons why I expect oil prices to stage a major rally.

1. Global Oil Demand Growth is Strong

There’s a popular myth that global oil demand has remained weak since the 2007-09 recession. That couldn’t be further from the truth: Global oil demand is expanding at the fastest pace in years.

Consider the most recent Oil Market Report released by the International Energy Agency (IEA) in mid-October. The IEA reported that third-quarter oil consumption trumped initial forecasts, coming in at 87.6 million barrels per day. That’s 2.4 million barrels per day more than a year ago, an increase of more than 2.8 percent.  

Most of that growth came from developing countries. Countries outside the Organization for Economic Cooperation and Development (OECD) consumed 1.4 million additional barrels per day of oil than they did 12 months ago. But the real surprise in the third quarter was renewed demand from the developed world; oil consumption in OECD countries increased by nearly 1 million barrels per day, including 700,000 barrels per day in the US and 100,000 barrels per day in developed Europe.

To put this into perspective, the last time global oil demand posted third-quarter growth of this magnitude was 2004, when consumption leapt by 2.6 million barrels per day. In fact, based on the same IEA data, 87.6 million barrels per day represents an all-time quarterly record for global crude oil consumption. It’s tough to characterize record demand and the strongest consumption growth in six years as sluggish. 

Economic data continue to point to recovery for the global economy, and the US and other developed countries appear to have exited a soft patch that began last spring. Governments worldwide disseminate hundreds of economic indicators each week, but one of the simplest, most influential and easiest to interpret is the Purchasing Managers Index (PMI). Readings above 50 generally indicate economic expansion, while readings under 50 suggest contraction. The graph below shows manufacturing and non-manufacturing PMI for the US, China and India.

Source: Bloomberg

Recent PMI data released for China and the US was well ahead of expectations and indicates continued expansion in both economies. The Chinese government has successfully engineered a soft landing, cooling economic expansion from the red-hot levels that prevailed early in 2010, but growth is picking up again.

Last Friday’s US employment statistics were also encouraging. The country added 159,000 private-sector jobs, double the 80,000 jobs economists had expected. Even better, the Bureau of Labor Statistics revised estimates for both August and September payrolls sharply higher to 143,000 and 107,000 private-sector jobs, respectively. A pick-up in labor market conditions will support consumer spending and indicates increased business confidence.

And in October US automobile sales hit an annualized rate of 12.25 million units. This is the highest level since July and August 2009, when the federal government’s Cash for Clunkers program artificially inflated demand for autos. Although the US is still a far cry from revisiting the 16 million-plus in annual car sales that was 2005-06, an uptick in auto purchases spells an incremental increase in fuel demand.

2.  Declining Oil Inventories

Over the past five years I’ve often argued against an overreliance on US oil inventory statistics. The US hasn’t been the driver of global oil demand in years. Nevertheless, some pundits insist on treating the US Energy Information Administration’s weekly stats as the oracle of Delphi. Bloated US oil inventories prompts some misinformed pundits to argue that the world faces a glut of crude. Unfortunately, this sophistic reasoning has led many investors to spectacularly incorrect predictions of an imminent decline in oil prices.

Nonetheless, inventory statistics aren’t useless and should be considered one of many indicators in the toolbox, not the Rosetta stone of the global energy markets. In that spirit, here’s a chart of total US oil and refined products inventories.

Source: Energy Information Administration

Total US petroleum inventories are still high by historical standards, but they’re falling steadily. Gasoline inventories (red line) have declined since early 2010, while distillate inventories–mainly diesel and heating oil–have dropped dramatically, a trend that should continue through the winter because of seasonal demand for heating oil.

More broadly, IEA data indicates developed-word inventories declined by about 600,000 barrels of oil per day in the third quarter, the first three-month decrease since 2008.

3.  Quantitative Easing Stimulates Inflation Expectations

At its heart, the Federal Reserve’s controversial quantitative easing (QE) policy is about combating deflation by encouraging an increase in inflation expectations.

The purest measure of inflation expectations is to compare the yield on a Treasury Inflation-Protected Security (TIPS) to the yield on a straight US government bond. If the yield on a normal government bond rises relative to a TIPS bond, that suggests investors are pricing in higher yields to compensate for the risk of higher inflation. Here’s a look at this indicator for five-year US government bonds.

Source: Bloomberg

Although expected inflation remains below where it was in late 2009 an early 2010, it has risen steadily since the Fed began hinting that a new round of quantitative easing could be in the offing. Rising inflation expectations are generally negative for the US dollar and, in particular, the value of the dollar against hard assets such as precious metals, agricultural commodities and oil.

Quantitative easing also benefits emerging markets such as China and India by setting up a giant global carry trade. Investors and companies can borrow cheaply in US dollars and reinvest that cash in emerging markets, where growth opportunities and interest rates are higher. The same countries that are the prime beneficiaries of the developed world’s easy-money policies are also the leaders in terms of global oil consumption growth.

4. Oil is Affordable (For Chinese Consumers)

Subscribers often ask what happens to global oil demand if crude oil prices rise steadily higher in coming years. After all, even at $80 a barrel, crude still trades at elevated levels by any historic standard, and high prices encourage conservation.

But crude oil is actually more affordable today for your average Chinese consumer than it was five years ago. Consider that in 2005 the average Chinese urban consumer had a monthly disposable income of roughly USD321. With oil trading at an average price of about $61 in 2005, disposable income priced in barrels of oil worked out to about 63.1 barrels of oil per person per annum.

Thanks to a steady rise in disposable income and the rising value of the renminbi to the US dollar, average annual Chinese disposable income works out to USD7,872 per year as of the third quarter of 2010. Assuming oil prices of $85 a barrel, Chinese disposable income works out to nearly 93 barrels of oil per person per year. In other words, your average Chinese consumer can afford more oil despite higher prices.

In contrast, at more than $36,600 per annum, your average US consumer has a much higher disposable income in absolute terms. But if we price that income in terms of barrels of oil, it’s actually shrunk somewhat over the past half decade. That’s because US disposable income hasn’t increased as quickly as crude oil prices.

5. OPEC-11 Looks Tight

The term “OPEC-11”refers to the eleven OPEC members with formal production quotas. Here’s a table showing their estimated production in October and their formal production quotas.

Source: OPEC, Bloomberg

Note that not a single OPEC member appears to be adhering to their official quotas, though some, including Saudi Arabia and Kuwait, produce close to the targeted amount.

Compliance with production targets often becomes spotty when oil prices rise; back in early 2009, with crude trading at depressed levels, most OPEC members complied with their targets because they needed higher prices to protect profitability. But as oil prices rose steadily from spring through year-end, the temptation to produce more crude and earn more profit became too much for many members. 

In a sense, although OPEC hasn’t changed its official production target, the de facto target has increased to the point that OPEC-11 is now overproducing by nearly 2 million barrels per day.

That being said, production from OPEC-11 is no longer rising; in fact, it has tailed off somewhat since midyear. Check out the graph below.

Source: Bloomberg

Thus, even as demand for oil rises to record levels, OPEC is actually producing less crude, tightening global supplies.

Generally speaking, Saudi Arabia–the largest and most disciplined OPEC member–would need to increase output for OPEC 11 to show a meaningful bump in production. That’s unlikely without a formal hike to the country’s quota. OPEC doesn’t appear to be in any hurry to hike output, though I do expect the group to make a move at some point next year. Ironically, when OPEC ultimately hikes its quota, this could be bullish for oil prices; it will mean spare production capacity–essentially the world’s buffer supply–falls.

Finally, Iraq is in OPEC, but has no formal quota. This brings me to my next point.

6. Iraq Not a Panacea

Two rather dubious facts you’ll hear quoted in the media are that Iraq’s oil reserves are larger than Saudi Arabia’s and that the country soon will produce more than 12 million barrels of oil per day, up from around 2.35 million in October.

Both claims are at best misleading and, quite possibly, downright irresponsible. First, the term “reserves” is widely misused in the media. Many quote reserves of oil in the ground as if it represents oil in some giant underground tank just waiting to be refined and used. But oil reserves are supposed to represent the amount of oil that ultimately can be produced economically.

What really matters to the global oil market isn’t how much oil is in the ground, but the rate at which that oil can be produced. This depends on a number of factors, including the quality of the reservoir, the quality of the oil produced and how long the field has been in production.

Reserves are also just an estimate, and the accuracy of that estimate is unknown, especially in OPEC countries. Also, consider that a country’s quotas and power within OPEC are based in part of the size of its reserves; there’s an inherent incentive to embellish numbers. Look at this graph of Saudi Arabian and Iraqi oil reserves since 1980.

Source: Bloomberg

You don’t have to be a cynic to find this graph a bit fishy. Saudi Arabia’s crude oil reserves remained basically constant, before taking a giant leap in the late 1980s. It’s also that these estimates never decline, though the country produces anywhere from 3 to 4 billion barrels of oil per year.

 In the case of Iraq, you must question whether the country can accurately establish its reserves when it was in a near-constant state of war and/or subject to some sort of economic sanction. Iraq’s most recent reserve adjustment to 143 billion barrels was announced in October and doesn’t appear in the graph. Once again, this is an overnight revision that’s not backed up by sound analysis.

There’s no doubt that both Iraq and Saudi Arabia are countries rich in oil wealth, but the idea that these proven reserve numbers are some sort of reliable statistic that can be used to prove that the world has plenty of oil is downright ridiculous.

Let’s also consider Iraq’s production potential. The contracts that Iraq signed with major oil producers in 2009 have production targets of 12 to 12.5 million barrels of oil per day by 2017–the source of the apocryphal 12 million barrels day of production.

Outside the ill-informed media, no one really believes that these are realistic targets. The IEA expects Iraqi production to fall substantially short of these goals, penciling in output of 6.5 million barrels per day by the 2030s. And back in 2009 the CEO of Total (NYSE: TOT) called the targets in the contract “crazy,” stating that achieving 7 to 8 million barrels per day of production “eventually” would be a huge success.

Even certain parts of the Iraqi government have jumped on the bandwagon. In late April the Ministry of Planning posted a five-year plan which projected that Iraq would produce 4.5 million barrels of oil per day by 2014, compared to more than 7 million barrels per day implied by the contracts the country has signed with major oil producers.

Iraq will become a more important oil producer in coming years and remains one of only a handful of countries with the scope to actually boost production by a meaningful amount. The country will also be a profitable market, especially for oil-services companies that will be involved in the drilling.

But don’t believe the hype about the country’s reserves and outlandish production targets; Iraq won’t be flooding the market with oil. 

7.  Gold Leads Oil Higher

Gold and oil prices have tended to trade in broadly similar patterns over the past few years. Lately, gold has been leading oil.

Source: Bloomberg

This graph tracks the spot price of Brent crude oil and gold. As you can see, gold prices topped out months before oil in both 2006 and 2008 and bottomed out a few months before oil in early 2009. The two commodities rallied in tandem throughout 2009 but began to diverge in spring 2010. In fact, crude has underperformed most major internationally traded commodities in recent months, likely due to overblown fears of a double-dip recession.

With global economic growth coming back, oil is finally rallying to challenge its April highs. I’m looking for oil to play catch up with gold and other commodities over the next few weeks, implying a move toward $100 per barrel.

8. Brent Leads West Texas Intermediate

West Texas Intermediate (WTI) and Brent crude oil are the two most widely quoted benchmark oil prices. WTI is the benchmark that underlies oil futures traded on the NYMEX; Brent is the basis of the London-traded Intercontinental Exchange (ICE) futures contract.

Analysts continue to debate about which benchmark is more relevant. Most investors should monitor movements in Brent crude and the relationship between Brent and WTI prices; Brent increasingly reflects fundamentals in global oil markets better than WTI.

WTI crude has a standard American Petroleum Institute (API) gravity of 39 degrees and a sulfur content of 0.34 percent. Oil with API gravity higher than 31 degrees is considered “light” oil and is easier to refine than heavy oil. Crude with less than 0.5 percent sulfur is dubbed “sweet.” Because sulfur is a pollutant that must be removed during the refining process, sweet oil is more valuable than “sour” crude that contains more sulfur. WTI is light, sweet crude oil.

Brent, named after an oilfield in the North Sea, is also light, sweet crude oil. But standard Brent crude has an API of just over 38 and a sulfur content of 0.37 percent; Brent crude is slightly heavier and sourer than WTI. Assuming all other factors are equal, one would expect WTI crude to be worth slightly more than Brent. In fact, over the past 27 years, WTI has traded at an average premium of $1.22 per barrel.

Currently, however, Brent trades at a premium of $1 a barrel to WTI, an anomaly that has been in place for much of 2010. Chemistry doesn’t explain this shift. The properties of standard Brent and WTI crude haven’t changed over the past 27 years, and WTI remains slightly easier to refine and lower in sulfur that Brent. Instead, this change likely reflects trends in global oil markets.

The market typically has regarded Bent crude as a key international benchmark, while WTI is considered the standard price in the Americas. Brent tends to reflect traders’ perception of international oil supply and demand conditions; WTI has a closer tie to US market conditions. 

Because oil demand has increased substantially in markets outside the US over the past decade, the price gap between Brent and WTI has expanded. In short, when Brent is expensive relative to WTI, international oil supply and demand conditions are tighter than in the US. This is the situation that prevails today.

At any rate, in recent years when Brent has traded at a premium to WTI, it’s typically corresponded to periods when oil prices were generally strong.

How to Play It

To play the coming rally in crude oil, focus on three broad groups: oil services, oilfield equipment and producers with growth potential.

Oil services and equipment stocks are entering the sweet spot of their cycle. North American oil drilling activity is soaring as producers target oil-rich shale deposits such as the Bakken of North Dakota and the Eagle Ford in south Texas. Oil services firms with the technology to produce these plays have raised their prices for certain key activities by as much as 50 percent since April alone. Producers are reporting waits of 60 to 90 days to have their wells completed because there simply isn’t enough capacity to meet demand. North American profit margins for the best oil services stocks are soaring.

The international up-cycle is just getting started. Some markets such as Brazil are already seeing a strong jump in spending and activity, though other markets continue to lag. But with oil prices on the rise, spending is starting to accelerate; international profit margins for the oil services firms are set to rise early in the New Year. With both US and international markets growing, the best in the sector are already rising in anticipation of that turn.

The last major oil services up-cycle lasted between 2004 and 2008; over that time many of the best-placed oil services and equipment names rose five-fold or more.  Similar gains are possible this cycle, and the time to buy is now.

Among the producers, look for companies with access to the best reserves. In North America, that means exposure to proven unconventional oil reserves such as the Bakken. And outside the US that means seeking out producers with major new finds and exploration upside.

Elliott invites you to join him aboard Holland America Lines’ ms Eurodam for the 2011 Money Answers Cruise. Departing from Fort Lauderdale on Feb. 12, 2011, for a week-long tour of the Caribbean, Elliott’s guests will enjoy a week of unparalleled luxury as well as unfettered access to some of the world’s top investing minds. For more details on this unique opportunity to recharge your batteries and portfolio, go to www.MoneyAnswersCruise.com or call 1-800-707-1634.