Q: What are your thoughts on the price of oil? Should a person invest in oil stocks now or wait?—Bev
A: The price of oil is poised to be a big investment, economic and political theme for 2015.
Let’s start with a primer on what’s driving prices lower, Bev.
Oil has been in the $100 a barrel range for about 5 years. Sustained high prices have made it profitable for certain companies and countries to drill for high-priced, hard-to-extract crude. The result is that the global oil supply has been increasing.
At the same time, global demand has been weaker due to slower growth in Europe and Asia. So demand, in a traditional sense, has been decreasing. In a less traditional sense, efficiency measures—like better gas mileage on new cars—have also caused weaker global demand.
So an increase in supply and a decrease in demand around the world have caused the price of oil to fall. This has been further magnified by OPEC’s recent reluctance to intervene and cut supply to prop up prices, which would be the standard response to a lower oil price. This reluctance is widely believed to be Saudi Arabia’s way to squeeze U.S. producers extracting high cost shale oil as well as Canada’s oil sands companies.
Now, to your question, Bev. Is now the time to buy or should you wait?
I’d say you need to start with some investment basics. My experience has been that the majority of investors—professional or otherwise—have a propensity to do the opposite of what they should do. That is, they buy high and sell low. It’s an emotional response that some academic studies have shown applies to even investment advisers and pension fund managers, perhaps even more so than do-it-yourself investors. So generally, I like your idea of buying low (now) with the hope of selling high (later). But how low will oil get? Any insight is just speculation.
Generally, I think it’s probably better to have a consistent approach to investing where you buy and sell based not on emotions or speculation, but primarily based on asset allocation. That is, if your target exposure to stocks is 60% and stocks drop for a period of time, you should rebalance your portfolio to bring your stock exposure back to the target. Likewise if stocks rise and become a larger portion of your investment portfolio.
In the case of oil, you should likely start by looking at your current oil exposure for an answer. Are you over or underexposed in the first place, Bev? Investors should consider their sector exposure as well as the stock/bond mix to ensure they are diversified and as one determinant of when to buy and sell.
If you are underexposed to oil, then yes, I’d say this further reinforces that now might be a good time to increase your exposure. And not directly because of the current price of oil in isolation, but indirectly because of the lower than target oil exposure in your portfolio.
It bears pointing out that the current economic and political intervention in oil markets—not to be confused with the constant economic and political manipulation of the price of oil—could prove to be a bit of a falling knife. As the Saudis try to squeeze out expensive oil producers, some of these producers could run into financial difficulty that leads to further declines in stock prices or even bankruptcies.
As the price of oil and oil stock prices fall, the likelihood of picking the “right” time to invest is probably increasing. But generally, I’d be inclined to base your timing decisions on asset allocation as opposed to speculation or emotion. It will also help you determine the right time to sell, which can be just as difficult to assess.
Especially in this day and age, the majority of stock market participants have the same information you have to make their stock investing decisions. They all know the price of oil has fallen. Whether or not oil stocks are fairly priced or have overshot due to a knee jerk reaction will be seen with time.
Jason Heath is a fee-only, advice-only Certified Financial Planner (CFP) at Objective Financial Partners Inc. in Toronto, Ontario. He does not sell any financial products whatsoever.