Profit from Peak Oil’s Bumpy Plateau

As we enter the new year, it’s time for everyone to come out of the woodwork and make their predictions for 2011.  In the past two weeks, there’s been a cacophony of expert opinions predicting higher oil prices this coming year.  JPMorgan Chase and Bank of America Merrill Lynch both predict $100/bbl oil.  The ex-CEO of Shell predicts $5 gasoline.  These predictions are backed up on Wall Street with oil futures recently shifting from contango to backwardation – signaling tight physical supplies of oil.  Many experts are stating that we’ve passed the peak of world oil production at least two years ago and that 2011 could become a repeat of 2008 for oil prices as we trudge through the “Bumpy Plateau”.

If the US economy maintains its brisk recovery in 2011 and the Chinese economy continues to increase its oil consumption at a record pace, the quickly-rising demand for oil will run straight into the wall of peak oil production in 2011, causing the price of oil to spike well above $100/bbl, and leading to a demand-destruction-induced double-dip recession.

The world economy can handle slow, steady increases in the price of oil, but fast spikes in the price of oil can have devastating consequences on the economy.  As I mentioned in my demand destruction post, there’s a possibility that this post-peak-oil environment will lead to a series of oil price spikes followed by market crashes.  As these spikes and crashes hit, the world oil production swings along with the price of oil, masking the true worldwide oil peak – this is referred to as the “Bumpy Plateau”.   As an investor, you should be looking to protect yourself and profit from these oil price spikes and market crashes during the bumpy plateau period.

The Peak Oil Bumpy Plateau

The way to profit from oil price spikes and market crashes during the “bumpy plateau” is as follows:
Step 1: Hold the Peak Oil Proof Portfolio now.
Step 2: “Sell High”: As the oil shock “alarm bells” go off, short the market, sell your holdings, put the proceeds into crash-resistant holdings.
Step 3: “Buy Low”: Use limit orders to buy the Peak Oil Proof Portfolio and high growth stocks at their lows following the market crash.

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Step 1: Hold the Peak Oil Proof Portfolio now.

The Peak Oil Proof Portfolio is designed to diversify your holdings across asset classes, industries and countries that are best positioned to profit from a post-peak-oil world.

The Peak Oil Proof Portfolio has been beating the S&P500 for the past few months, showing the strength of these holdings.  This portfolio will allow you to profit from the current market and will limit the damage to your portfolio of a market crash should you fail to get the timing right.

Step 2: “Sell High”: As the oil shock “alarm bells” go off, short the market, sell your holdings, and put the proceeds into crash-resistant holdings.

This is the difficult step, as it requires you to keep an eye on the market and to move quickly when an oil spike occurs.

One way to look out for a oil price spike is to analyze the current price as a ratio of the S&P500 to Oil.  In a price spike, this ratio typically goes “out of whack” as the price of oil moves much faster than the market.  As I mentioned in the demand destruction post, if the S&P500/Oil ratio goes below 12, the oil price spike is nearing the limit that the market can handle, which usually leads to a market crash.  Using a ratio of 12 is conservative, and it won’t maximize your profits.  In the last two oil shocks the ratio actually dipped below 10 for a few days – so a more aggressive ratio (such as 10) can be used to try to maximize your profits if you’re willing to take a bigger risk and keep an eye on the ratio minute-to-minute.

If you look at most recent oil shocks, you can see that the price peaks were signaled by sharp changes the price of oil right before the price spike caused a market crash.

  • 1990 Oil Shock:
    • Throughout July 1990, oil prices were around $20/bbl – an S&P500/Oil ratio of 15-20
    • Iraq invaded Kuwait on August 2nd; oil prices doubled to around $40/bbl over the following 2 months – an S&P500/Oil ratio of less than 10 as oil exceeded $35/bbl
    • The price spike pushed the US economy into a recession in October of 1990, causing the stock market to crash over 20% and pushing the price of oil back down to $20/bbl by the end of the year
  • 2000’s Energy Crisis:
    • Starting in 2003, oil prices steadily rose from an average of $30/bbl to a top of $147/bbl in 2008.
    • Throughout most of this increase in oil prices, the change was slow enough that stock market increased along with the oil prices to keep the S&P500/Oil ratio around 15-20
    • In the early summer of 2008, the price of oil spiked and the S&P500/Oil ratio dropped below 10.  Shortly after this signal in mid-July, the oil hit an all time high of $147/bbl, the market crashed in October and the world entered the “Great Recession“.
    • By the end of the year, oil prices had fallen down to $30/bbl – back to a 15-20 S&P500/Oil ratio.

In 1990, you could have shorted an oil ETF (if they had existed) at a price of $35/bbl (when the S&P500/Oil ratio dropped below 10) and then bought the ETF 3 months later at $20/bbl to cover your short, for a return of 75%.

Similarly, in 2008, you could have shorted an oil ETF at a price of $125/bbl (when the S&P500/Oil ratio dropped below 10) and then bought the ETF 6 months later at $30/bbl to cover your short, for a return of over 300%.

So once you see the S&P500/Oil ratio drop below 12, you should start selling your stocks, and putting the majority of the proceeds into stable currencies and stores of value.  Some examples of “stable” holdings are:

  • US Dollars – in your account as cash
  • Gold – GLD
  • Swiss Francs – FXF

Then, you should take some of your proceeds (as much as you’re comfortable gambling with) and short the market.  Some examples of ETFs you can short are:

  • The Market – SPY
  • A Consumer Discretionary ETF – XLY
  • A Financial Stocks ETF – XLF
  • Real Estate – IYR

For your short positions, you can put in “buy to cover” limit orders to close out your positions and take profits as the market crashes.  Using a series of limit orders will allow you to gradually close out your order without having to stare at a computer screen all day.  For example, if you start shorting SPY with $15,000 while SPY is at a price of $150, you’d short 100 shares of SPY, then you’d put the following orders in:

  • Close out 20% of your holding if SPY falls 20%: Place a “buy to cover” order for a 20 shares at a limit of $120
  • Close out 40% of your holding if SPY falls 30%: Place a “buy to cover” order for a 40 shares at a limit of $105
  • Close out 40% of your holding if SPY falls 40%: Place a “buy to cover” order for a 40 shares at a limit of $90

Step 3: “Buy Low”: Use limit orders to buy the Peak Oil Proof Portfolio and high growth stocks at their lows following the market crash.

In much the same way that you should use limit orders to cover your short positions as the market crashes, you should use limit orders to buy stocks at discount prices.

For example, you can use limit orders to purchase VDE, one of the ETFs I recommend in the Peak Oil Proof Portfolio, at a discount following a market crash.  If VDE’s high was $120 before the crash and you want to own $60,000 of it, during the crash, you can put in some limit orders to purchase it at cheap prices:

  • Buy 20% if it falls 20%: Place a buy order for a 125 shares at a limit of $96
  • Buy 40% if it falls 30%: Place a buy order for a 285 shares at a limit of $84
  • Buy 40% if it falls 40%: Place a buy order for a 333 shares at a limit of $72

Of course these limit prices are just an example and you’ll need to adjust the prices and quantities based on how much you want to invest, how how far you think the market will crash and what balance you want to strike between buying low and risking not being able to buy at all.  This should be repeated for all of the ETFs in the Peak Oil Proof Portfolio.

A market crash also gives you the opportunity to purchase some “high growth” ETFs while they’re temporarily inexpensive.  Some examples of ETFs that you might want to snatch up are:

  • China Small Cap – HAO
  • India – EPI
  • Emerging Markets – EEM
  • Gulf States – GAF

With oil prices low from demand destruction, these high growth stocks could easily out-perform the Peak Oil Proof Portfolio as investors pile back in to stocks once the market begins to recover again.  These high growth stocks can be held until oil prices begin to climb again, at which point they can be sold and the proceeds can be invested into the Peak Oil Proof Portfolio, which, due to its commodity-heavy holdings, should outperform the market as oil prices reach their highs again.

Will Martin is an energy analyst and expert on peak oil and alternative currencies. He is an MBA graduate of Cornell University, where he was a Roy H. Park Leadership Fellow and concentrated on studying sustainability in business through the school’s Center for Sustainable Global Enterprise. Prior to his MBA, Will worked in the energy industry, living in Singapore, Houston and Dubai. Will is a recipient of the 2012 “Pioneer Award” from the Association for the Study of Peak Oil and Gas (ASPO-USA). He currently works as a carbon trading commercial adviser in the San Francisco Bay Area. Will is a bitcoin enthusiast and in 2014 published the book “Anonymous Cryptocurrencies,” which became a #1 best seller in 3 Amazon categories and was the first book to be sold on a decentralized marketplace.

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