Is The Oil Bull Market An Illusion?

Includes: DBO, XOP
by: Plan B Economics

Question: What goes from $22 to $95 in 10 years, but doesn't really rise in price?

Answer: Oil

I warn you that this article may jerk your senses. It did mine and I'm still not sure what I believe. Nevertheless, read on and let me know your thoughts.

Oil prices (PowerShares DB Oil Fund - DBO) have been rising steadily over the past decade or so. Most investors point to emerging demand from China and other rising economic behemoths, as citizens of the world demand the typical Western middle class lifestyle that entitles one to a car, meat and jet travel. At the same time, marginal additions to global oil production are coming from more expensive wells and the old elephants are showing signs of fatigue. Supply and demand, baby!

Some call it 'peak oil', and for me that was a sound explanation. As finite resources become scarce, prices rise resulting in oscillations between boom and bust. While oil shot from about $22 to $146 to $30-ish to $95 as the marginal barrel was subtracted, added and then subtracted from the global market, the secular bull market in oil prices persevered.

But is the oil bull market an illusion?

Was the boom-bust-boom in oil over the past several years simply a function of the value of the US dollar?

The chart below shows the amount of oil received in exchange for two currencies: gold (SPDR Gold Trust - GLD) and US dollars. Since 1900 the oil received for an ounce of gold (black line) has fluctuated within a band. More notably, since the end of the Bretton Woods currency regime in 1971, the fluctuations in the oil-for-gold ratio have not deviated from the historical trading range.

Compare this to barrels per dollar (green line), which has declined steadily since the late-1930s. For nearly a century, monetary policy has devalued the dollar, which has been reflected by the price of gold and oil.

As an energy bull, this made me think twice about my thesis. More investigation is required, but my early indications suggest oil prices may have risen primarily due to the growing abundance of US dollars. If gold is the ultimate stable currency, and all other currencies are devalued over time into oblivion, does this suggest that real oil prices have remained fairly stable over the past century?

What this could mean for US investors is that oil company stocks (SPDR S&P Oil & Gas Exploration & Production ETF - XOP) are nothing more than a dollar hedge and a play on crack spreads. This doesn't necessarily mean oil company stocks are bad, but they might not the 10-baggers many expect on a dollar-adjusted basis.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: This is not advice. While the author makes every effort to provide high quality information, the information is not guaranteed to be accurate and should not be relied on. Investing involves risk and you could lose all your money. Consult a professional advisor before making any investing decisions.