In 2007, I was concerned…very concerned. While trying to understand what was beginning to happen in the markets and the economy, I was on a research tear. Anything I could get my hands on regarding stocks, gold, the Federal Reserve Bank, and oil was devoured in short order, as I sought answers for how the pieces of the financial markets fit together. It was during this time that I began reading about peak oil, a term used to describe the point at which rising demand for oil reached a point that coincided with the declining supply of oil. It was from the point of peak oil that oil prices would forever climb higher and higher, driving worldwide economies into turmoil, resulting in unending war over the precious and increasingly scarce resource. To put it bluntly, it’s a terrifying idea when you recognize all that runs on abundant and cheap oil.
Given the scores of books and articles that sounded alarms over peak oil, how does one reconcile today’s oil price with that quiet hysteria recently felt by so many knowledgeable of the oil business? How can oil prices have dropped to less than half of their “peak” in such a relatively short time? And moreover, what does that mean for each of us who are investing in the stock and bond markets, while simultaneously enjoying cheap gas at the pump?
Sadly, there’s no free lunch. Just as low interest rates mean a new homeowner can enjoy a lower mortgage payment, the elderly saver suffers from paltry CD rates at the same bank. So it is with oil prices. The same person who is able to fill up the SUV for a fraction of what was required just a couple of years ago, scoffs at the low returns from his investment portfolio that is invested in some of the largest companies in the world, oil companies. One cannot easily get benefits without some commensurate costs. Same coin, two sides.
So as to not miss one of the larger points here, let me offer that peak oil was a major concern just a few years ago, yet we now see oil prices having dropped sharply. That simply should not have happened. An energy market expert sitting on her perch looking over the horizon would have been crazy to predict such a steep drop in oil prices. It’s almost unimaginable. The cost of oil is why so much work was done to develop other means of extracting oil from the earth: shale and fracking. When prices were high, investment in innovation was a no-brainer. When innovation works and leads to lower prices, innovation slows because the financial incentive is lessened.
What I’m hoping to convey to you are two distinct truths: very few trends last forever and rarely does one receive great benefit without cost. In other words, oil prices didn’t continue to climb higher and higher, uninterrupted. And low gas prices aren’t possible without similarly low oil prices. When oil plays such a large role in our economy, market returns will also be affected.
So, what does all of this mean? I’d like to remind each of us of the power and necessity of diversification in our investments. By owning many, many types and styles of assets in a portfolio, the chances of us being meaningfully harmed by a shock to one class of asset are reduced dramatically. As an example, had I acted on a hunch to pour all of my eggs into the energy basket back in 2007 (I was tempted to), I would have been in rough shape as a result. Many people made this bet and many people were hurt by it, very much like the large bet many made in gold around that time.
Don’t get me wrong, you and I should absolutely enjoy gassing up the car with cheap gas, but keep in mind that no trend lasts forever, and lunch – at least one worth eating – is very seldom free.
All the best,
Adam Cufr, RICP®
