Investing In Oil? Read This First!

A weak U.S. dollar, diminishing supplies of easy oil and growing worldwide demand has turned crude oil into liquid gold over the past decade. In addition to supply / demand changes there have also been several innovative products such as the Oil ETF and ETN that have supplied further upward pressure. A persistently weak dollar over the past 10 years has also been a source of market support and many think this trend will continue or get worse. Should you be investing in oil? What would be the best way for you to start investing in oil?

There is really only one reason to invest in oil as a commodity and that is if you believe the price will rise in terms of U.S. Dollars in the future. Cash oil prices have risen from a low of $10.80 in December 1998 to a high of $145.66 in July 2008 so anyone who purchased it in 1998 could have made over 1000% return on the rise in oil prices. The problem with high oil prices is that it puts extreme pressure on consumers and slows the economy which in turn causes demand to fall along with prices. Huge swings in the demand for gasoline and fuel especially in the U.S. tends to cause big swings in the price of crude oil and related products as well. After rising over 1200% between October 1998 and July 2008 prices turned around and fell almost 80% in only 6 or 7 months at the end of 2008, so this is not a market for the timid.

Most people are much better off owning an oil stock etf which contains a basket of oil related stocks instead of owning the actual commodity. The reason being that oil stocks tend to be less volatile than the actual commodity, also if oil prices don't rise but simply remain where they are today $80-$100 the oil companies will continue to pump out strong profits quarter after quarter so stock prices can continue to rise. If you look at the comparison (below) of the price performance between USO the most popular crude oil etf and XLE (Brown Line) the most popular Oil Stock ETF you will see that XLE has strongly outperformed USO since it's inception and this will most likely continue into the future.

USO or even the double oil etf - UCO can be used for trading short term swings in the price of crude oil, but you need to have good timing skills to make money at that game. Another way traders use financial derivatives is to short the crude oil market by using the double short ETN DTO or double short ETF SCO. Both of these will rise 2% on a day when crude oil falls 1%. Most of these financial instruments are designed for short term traders and do not work well for long term investors. For longer term investors the return they can achieve from a good oil stock ETF such as XLE is hard to beat.