Over the past decade, oil has become a very popular investment theme, as demand from China and India, as well as other developing countries, has driven demand up to available supply. At the same time, innovative new products like the Oil ETF have caused a sharp rise in investor demand. As with other commodities, the weakness of the US dollar is the underlying factor that has caused oil prices to rise over the past decade. Should you invest in oil? If so, what is the best way to start investing in oil?
The main reason you would want to invest in oil is because you think oil prices are going to go up over time. 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 bought it in 1998 could have made a return of over 1000% with rising oil prices. The problem with high oil prices is that it puts extreme pressure on consumers and slows down the economy, which in turn causes demand to drop along with prices. These changes in demand with fairly constant supply cause prices to move quite a bit, which can be seen on a regular basis. During the credit crisis of 2008, oil prices fell from a high of $145 to $30 per barrel in a 7-month period, so it’s not a market for everyone.
For the average person who wants exposure to oil prices, it’s probably a better idea to buy a basket of oil stocks (using an oil stock ETF) rather than buying the actual commodity (using futures or an ETF). The reason is that oil stocks tend to be less volatile than the actual commodity, plus if oil prices don’t go up but just stay where they are today ($80-$100), oil companies will continue to generate strong earnings quarter over quarter, so stock prices may continue to rise. If you look back at the price performance comparisons between USO (the most popular crude oil etf) and XLE (the most popular oil stock ETF), you will see that XLE has far outperformed USO since its inception and most This is likely to continue in the future.
If you intend to trade crude oil prices short, you may want to trade USO or the long leveraged version of ProShares (UCO). You can also gain downside exposure by buying the ETF – SCO or the ETN – DTO, which are designed to rise as the price of crude oil falls. Most of these financial instruments are designed for short-term traders and do not work well for long-term investors. For the long-term celebration it is difficult to be the performance of XLE.