What Oil Prices Are Saying

If you wanted to get a forecast of what U.S. economic growth will look like in 6 months,
most people would ask an economist. After all, economists are the ones with
their fingers on the pulse of economic activity.

In general, economists would say we have 2.5%
GDP growth for the rest of this
year, and we should hit 3.2% by the end of 2011. After last quarter’s 1.6%
growth, these numbers sound pretty good.

If you asked an oil trader, you get a similar picture of
improving economic activity. Oil futures for October delivery are currently
trading around $74 a barrel. But if you want to wait until March 2011 to get
that oil, it will cost you just over $80 a barrel. And while the front month
futures contract fell overnight, the March contract rose in value.

There are several reasons that oil futures are experiencing
“contango”, the situation where current prices are lower than future

One is clearly the growth story. Demand is expected to rise
along with economic activity. And oil traders are betting that oil prices
will be higher 6 months from now.

Another reason is storage costs. It costs money to store
oil, and with inventories running very high, the costs of ownership are being
offset with the more expensive March futures contract.

Oil companies are already leasing tankers to store their
excess supply. It’s clear that these oil companies believe they will offset
their storage costs in the future. And they are also keeping supply off the
market, which supports current prices.

Oil hasbecome an
investment asset, on top of being a critical commodity. People may or may not
need to buy an iPod or new clothes or choose to put off such purchases into
the future. But oil use can’t be put off. And it can only be trimmed by a
certain amount. It’s likely that we’ve already seen the lowest levels of
demand we will see during this economic recovery.

It seems to me that we are quickly returning to the oil
price environment that we had between 2005 and 2007, when oil made its
historic run to $147 a barrel.

We may not see such high prices anytime soon. But the
conditions for a move higher for oil prices, where oil is both a commodity
and an asset, are in place.

Oil is a finite commodity. We’re not finding more of it, at
least not in large enough volumes to both replace lost production from
declining fields and keep pace with a growing global population.

And while we can clearly see oil traders looking forward and
seeing higher oil prices, oil stocks are not trading with the same kind of
enthusiasm and optimism right now. P/E’s of 10-15 are not uncommon. And
that’s based on current pricing.

Clearly, a move higher for oil prices means better earnings
and lower valuations for oil stocks. If you’re looking for some oil stock
ideas, I’ve got some great ones in the
Energy World Profits
portfolio. Click
for more.

I’ve had a few
Daily Profit write in to say that they are intrigued by
getting into cheap bank stocks like Bank of America (NYSE:
BAC), but are not sure if now is the right time
to take the plunge.

A little caution is always a good thing. But being overly
cautious will lead to missed opportunity and regret. So why not adopt a
cautious strategy to buy stocks that look attractive even though the outlook
may be somewhat uncertain?

I’m talking about averaging into a position. Especially when
stocks (and the economy) look uncertain, investors can divide their
investment allotments into smaller portions, and buy a stock over a period of

In the case of Bank of America, purchases over the last 2
months would have meant buying between $15.50 and $12.50. Your average price
would be around $14. That looks a lot better than owning the stock above

Remember, too, that banks have been weak since

Right now, Bank of America is very cheap, trading just above
tangible book value. (JP Morgan looks cheap as well). It’s up around 8% since
I recommended it last week. I expect it will be back in the $15 range soon

As always, let me know what you’re thinking: [email protected].

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