In Light of Peak Oil, Financial Diversification Is a Bad Idea

by: Michael Fitzsimmons

The realities of peak oil and the disastrous US monetary policy of the last 8 years have completely changed the rules of investing. Pick up any financial publication - be it Money magazine, investment publications from Vanguard, or articles by the lead economists at firms like Schwab and Fidelity and you will still see a common theme: advice from money managers to have a well diversified portfolio. I am here to tell you that this is good advice for them, but terrible advice for you. Here's why.

Most investment advisors these days continue to promote a nice pie chart which is broken down into easily understandable slices. Typically, these slices include US stocks, international stocks, bonds, and cash. Some investment advisors have added commodities to the pie. Along with the slices, the advisors provide us with percentages, usually indexed to the investors age. Common advice might be something like: 40% US equities, 20% international equities, 20% bonds, 10% commodities and 10% cash. This is simply an example, but you get the idea.

Why do I believe this to be a bad idea? For US investors, the realities of peak oil mean the following: energy prices will continue on an upward climb and therefore inflation will follow. The massive devaluation of the US dollar since Bush took office (>50%) will simply exacerbate the problem since oil is traded the world over in US dollars (at least for now!). As readers are aware, I have often commented that the US dollar has been replaced as the world's "reserve currency" by a barrel of oil. Regardless, what do the realities of peak oil mean for the diversified investor?

Let's take a look at the pie. For the 40% of US equities (remember, these percentages are simply examples), if we assume this to be invested in the S&P500, only 15% of that will be in energy since that is the approximate energy weighting today (energy recently leap-frogged financials in this respect, which is a big red flag in itself for those paying attention). So, 15% of 40% and the investor will have roughly 6% of his money in energy. Hmmm...that's not very good. Considering the last 10 years the S&P500 has returned around 3.5%, now wonder people are complaining about their portfolios balances! Meanwhile, in that same period, many energy investments have been up 25-30% per year.

International equities is a bit of a different, and better, story. The falling US dollar has been a boon for foreign investments. Those investors which have been astute at foreign market picks have really done well. That said, in the future investors would be well advised to keep their foreign investments in countries that produce oil: Brazil and Russia come to my mind.

Most US bonds and fixed income in general is dead money. With low US interest rates (2.5%), high inflation (over 5%, don't believe the government data, which everyone knows is fudged), and a US currency that has been dropping 6-7% per year, most US fixed income investments are simply a way to fall behind in terms of capital preservation, let alone capital appreciation.

Commodities is a good bet. If the investment pie has a 10% slice in commodities, shake your advisor's hand. Oil, natural gas, gold, silver, wheat, cotton and soy beans are all good. These investments are real, or hard, assets and will surely help the US investors keep pace with inflation and a devalued currency.

"Cash" is a bad idea unless you place it in US dollar hedges like the Merk Hard Currency Fund [MERKX] or the Prudent Global Income Fund [PSAFX]. Cash simply won't keep up with inflation and the falling currency.

So, of the investment pie the professionals advise, only 21% are in assets that protect the investor from the realities of peak oil and a devalued currency: the 6% in energy and the 10% in commodities. Over the past 10 years, this formula would have been a losing proposition once inflation and the falling value of the dollar are taken into account.

What's an investor to do? First of all, forget diversification - it is a way to the poor house in the years ahead. Forget the S&P500 and US bonds. Concentrate your money in energy, precious metals, and commodities. Period.

Here are some great choices to outperform the market in the coming years (in no particular order):

  • ConocoPhillips (NYSE:COP)
  • Exxon Mobil (NYSE:XOM)
  • Chevron (NYSE:CVX)
  • StatOil (NYSE:STO)
  • Schlumberger (NYSE:SLB)
  • Nabors Industries (NYSE:NBR)
  • Chesapeake Energy (NYSE:CHK)
  • Anadarko Petroleum (NYSE:APC)
  • GLD (Gold ETF)
  • DBC (Commodities ETF)
  • Vanguard Energy [VGENX]
  • Vanguard Precious Metals [VGPMX]
  • Fidelity Select Energy Services [FSESX]
  • Fidelity Select Natural Gas [FSNGX]
  • Merk Hard Currency Fund [MERKX]
  • Prudent Global Income Fund [PSAFX]

Buy these stocks, funds, and ETFs and just hold them. Don't let day-to-day headlines or huge energy volatility scare you out of these positions and you will do fine over time. As an aside, the oil inventory report just came out today, and oil inventories were down over 8 million barrels, a big big surprise versus estimates. Anyone remember Gomer Pyle - "Surprise, surprise, surprise!" Still, there is no comprehensive US energy policy out of Washington, DC.

Dow Chemical yesterday specifically pointed to the lack of a comprehensive US energy policy as a big reason for having to raise its prices. This is a scenario the investor should get used to, and be prepared for in the years ahead.

Meantime, if you'd like to send your Congressman/woman or Senator a real comprehensive energy policy, please send them this link.

It will definitely be the most patriotic action you take this day. Thank you!