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Oil headed for 50 or 80 ?

Oil has come down by more than 50 % from high of 147 reached just three months back and has touched $62. Opec had an emergency meeting on Oct 24 and announced cut of 1.5 M barrels. So that begs the question ? Which direction oil is headed and how one can invest based on oil direction? (last time I predicted oil reaching $100 and recommended some airlines which did ok considering the overall direction of market)

The way oil price overshoot in July in upward direction, this time it has overshoot in downward direction and this is all because of extreme speculation by hedge funds and index/ETF investors like ourselves. The demand for oil has moved around 85 millions barrels per day and supply has been managed around that demand. Even with slowdown in economy, demand has come down by single digit percentage. So in rational terms, swing of 100% in oil price does not make sense. If we take basic marco-economic principle, marginal cost of producing one barrel of oil is about $70 to 80. In theory, if price goes above incremental cost, more investments would flow, supply would increase and price would come down to marginal cost of production and same goes in other direction.

So in long-run, oil should trade between $70 to $80. Currently it is trading at around $64. Assuming that it would overshoot or undershoot by about 20%, I am expecting oil prices to trade between $56 and $96. Since current price is very close to low-end of my target, oil price is likely to start its upward move (it may go towards $56 in short-run) and may touch $80 by year-end.

So how one can invest and possibly profit from this theory. My recommendations would be to check out fidelity mutual funds (FSESX, FSNGX) or if you want to be more aggressive, check out DIG or directly go with leaders like XOM or SLB

Looks like after my last article about "Bargains Everywhere?", stocks became even more cheaper. My guidance is not to look for short-term bottom since no-one could predict exact bottom. As long as you are in stocks for long-run, these weeks would provide one of best opportunities to invest in stocks - if you want some data, check out lows of 2002

Have a good weekend !

/Shyam

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