Energy: The Single Most Important Factor for Your Investments

Aug.12.10 | About: The United (USO)

The most important thing for your investments isn't gold or the dollar, or the consumer price index or Treasuries or even the stock market.

It's energy. More specifically, it's crude oil. Oil absolutely dwarfs everything else.

As I wrote back on June 3:

...in April of this year, a new daily volume record was set on the Intercontinental Exchange (ICE) for West Texas Intermediate Crude (WTIC) contracts - with an astounding mark of 464,381 contracts traded in just that one day. Each contract trades 1,000 barrels of oil.

With oil prices around $84 that day, each contract was worth about $84,000. So, it means that over $38 billion worth of oil contracts traded hands in that one day alone.

Granted, that was the daily record, but the WTIC futures regularly bypass the $30 billion mark on an average day. To put it in perspective, $38 billion is more than the annual earnings of Wal-Mart (NYSE:WMT), the world's largest corporation.

Furthermore, WTIC is just one type of crude oil, traded on just one futures market. There are at least a half-dozen other crude oil contracts in a handful of different futures exchanges.

So you ignore crude oil at the peril of your entire portfolio. While President Obama and Congress bicker over the crumbs of the economy, and the mainstream media frets over jobs, the recovery, inflation/deflation, and Wall Street pumps out a new ETF every week - practically no one is ringing the warning bell about what's going on with oil.

Sure, the BP (NYSE:BP) spill was in the news for months, but no one in the press took the opportunity to bring the much larger issue of where/when and how this nation will fare in the coming months and years as regarding our access to oil, or even gave a token nod to the fact that the price of oil has more than doubled over the past 12 months.

Okay, so not everyone has been asleep at the wheel.

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This chart basically shows how a doubling in oil prices has always (so far) predicted a recession for the following 12 month period.

It predicted the recessions of 1974, 1980, 1999, 2008, and now it's predicting another recession for 2010.

Okay, I'm not a technical analyst by any stretch of the imagination, so I'm really not interested so much in the idea that this "chart" predicts a recession, so much as I am interested in why it does so for fundamental reasons.

So far, I'm not exactly sure why this indicator has been so accurate - but I have a few theories.

Of course a recession by definition is backwards looking. The standard definition of a recession is when productivity (GDP) falls for two straight quarters. You can't really know if productivity has fallen until after the fact, since the government and other market measuring bodies do not yet have crystal balls or time machines.

My main theory (which I'll focus on today) ties in directly with my opening statement: oil rules. So if the most important commodity, asset, widget and product for world productivity doubles in a YOY capacity, it probably means that it's gone too far, too fast and that the world's producers are not able to produce as much.

Oil is the main input for almost any productivity equation, whether we like it or not. So if it doubles in price, it means that everyone's productivity result has to diminish by some factor, depending on how much the price of oil hits the bottom line. Industries that are highly oil intensive (like shipping) will get hit worse than less energy intensive industries like, say, telecoms or healthcare.

There are exceptions - and it might be that these exceptional industries, that are off the teat of oil will be the ones to thrive during the death throes of peak oil - but right now I'm more interested in what we can expect on a macro level.

I'll be going into some specific investment ideas in tomorrow's issue - but if I can leave you with one thing to keep in mind, it's to remember the importance of oil - even for non-commodity investments. You need to look at all of your investments, from stocks even down to bonds and savings accounts, and think about how oil price fluctuations could affect the bottom line of the underlying assets and businesses you're invested in.

Disclosure: No positions