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My Thoughts On Oil

|Includes: CRLFF, CVE, Enbridge Inc. (ENB), HUSKF, SU, XLE

Publishing your investment ideas on a public forum is fraught with risk. People with different views will provide comments to dispute your thesis and others just take pot shots. I have a lot respect for SA authors who take the time to write an article and make pennies for their effort and then have to put up with a barrage of comments from random people who have no clue about the author's thought process or knowledge of the market.

I will admit that the market will make fools of anyone who tries to predict it's behavior, but that doesn't prevent us from trying.

Oil Has Bottomed

There - I have done it. I have made a bold prediction that the bottom for oil is in. What is nice about this blog is that I can write down my thoughts and point people to the place, date and time that I wrote this.

So why do I think the low is in? There are a number of clues and more recently some encouraging trends that cannot be ignored.

Oil Storage Is Not Filling Up.

I am not a commodity analyst, but Robert Balan is and he has some interesting charts and notes about the futures curves that cannot be ignored. If you don't follow commodities, sometimes the terms don't make sense, so feel free to ask why these may be significant. You can read his work here. In the end, what this all means is that the professionals in the industry are the ones we need to listen to and not the news media.

Oil Equities Are Outperforming Junk Energy Bonds

I have learned that oil equities have outperformed oil bonds for the first time in months. This tells me that investors are feeling more confident about the survival of the industry rather than just getting their money back - this is an important upturn in energy sentiment. If you are not a professional investor, then funds XLE and XEG especially look good to me. At current prices up to 80% of the Canadian oil industry is not profitable. This cannot be sustained.

Volatility Is Up.

We have been languishing at these low prices for quite a while, until last week, when oil rose 15% in just 3 days. Volatility is often the beginning of something different. So if you are an oil investor, you already know that oil appears to be bottoming for the past few months. I have learned a lot about volatility from SA blogger South Gent. You can read some of his thoughts on volatility and the current UVP - Unstable Vix Pattern here.

I get news from many sources, one of them is BNN and here Jodie Gunzberg, Global Head of Commodities, S&P Dow Jones Indices comments, "We've only seen gaps up like that twice before, once in 1991 and again in 2009." Her thoughts from a video.

She goes on to say that the current price is a combination of both a supply shock and a demand shock. While OPEC has been trying to maintain market share, China suddenly was buying less oil and Yuan devaluation made oil more expensive. So on a rebound we could experience both a supply shock as well as a demand shock at the same time to the upside.

"We could experience a sustained rally in oil of at least 200% over the next 2 years with a demand rebound"

I feel that the strength in the oil market will be longer than 2 years because CAPEX cuts have been quite deep AND demand is growing. In the history of oil we have never experienced both a supply shock and a demand shock at the same time of which I'm aware.

My information comes from analysts that I follow and my bullish bias on oil may cloud my thinking - but there are more than two clues that the bottom is in. We have big price spikes and energy equities are outperforming energy bonds. We are missing only one ingredient for my thesis to become certain. US inventories must be lower or at least declining. I expect this to occur by April 2016, which should cement my thesis. Depending on how the Cushing inventory news is interpreted, we could experience another price swoon in March, but I don't think we will see new lows.

What I cannot predict is the effect of high inventories on the time frame (although probably $50 by December 2016) and I cannot predict a supply response from shale producers or drilled-but-uncompleted wells. Both of these will be temporary, but unpredictable.

I would like to have a clear strategy for myself moving forward, so this information doesn't really change my positioning much other than what I've already done. I am 22% energy and I can't reasonably justify any more than this.

To hedge my bets on energy, I am also buying 3 year or longer rate reset preferreds that have been beaten up by the energy outlook, changing credit profile of energy companies and the possibility of increasing interest rates.

Strategies To Consider

I have been wrong on the oil rebound since I first tipped back into oil in January 2015. Surprisingly, my realized energy losses are quite low considering how early I started. Of course, it has been a wild ride which may continue. So if you are reading this and following me, know that I could be completely wrong. I have been adding on significant dips and even writing puts to get my favorite stocks cheaper. In writing a dozen put contracts, I have only been assigned once. This extra income has been welcome considering my losses on the long portion of my portfolio.

For investors that don't share the comfort of picking individual stocks, I can recommend an ETF which if you just hold, will eventually recover. XLE (or the Canadian iShares Energy Capped Index Fund - XEG) are the best choices, in my opinion. The other option is to simply buy and hold your favorite large cap XOM, CVX or SU.

I am long CRLFF, ENB, HUSKF, CVE and hold put option positions on XOM, SU, CVX and may go long on XLE, XEG or any of my current long holdings within 72 hours.

Disclosure: I am/we are long ENB, SU, CVE, HUSKF, CRLFF.