How Investors Can Really Cash in on a Rebound in Oil

Oil

Oil stocks have been infamously bad for a long time, but nothing on the scale of what has happened lately. Oil is simply too important to be kept down this low for all that long.

Our economy has run into a brick wall lately, which has a lot of investors scurrying around for opportunities. Among the sectors that have been hit the most, the oil sector is head and shoulders above everything else, as this sector was already in a world of pain before all this happened, and are like a 90 year old man who just got the coronavirus, in the ICU hooked up to a bunch of tubes.

This particular patient cannot die though, or we all will die actually. Naïve climate activists may wish and pray that oil and other fossil fuels will just go away, and perhaps they will 100 years from now, but they are our life support right now. We’ll have to one day figure out how we will survive without oil, and survive is definitely the right word here, but we are many years away from even coming up with good ideas.

This doesn’t mean that particular oil companies aren’t subject to going away, and plenty might from this turmoil, the smaller ones at least, ones that simply cannot survive with oil around $20 a barrel. Oil itself won’t though, whether it does trade all the way down to the single digits or not.

There are some out there who think it might go this low, but we need to realize that this is a game of chicken and eventually it needs to go up or Saudi Arabia’s economy will die. Saudi Arabia may be able to make a profit at $10 a barrel but nowhere near enough to allow the country itself to stay above the water, and they are already swallowing plenty of water at $20. The King will not go as far as to watch his country drown.

Oil is suffering a double attack these days, from the price war between Saudi Arabia and Russia, as well as from the loss of demand caused by the world trying to strangle itself economically. Neither can last very long, and when it does rebound, there is a huge opportunity to cash in as investors.

We don’t want to be playing the stocks here with this opportunity though, as there are too many other factors at play, not the least of which is the market’s hatred of these stocks. It is far better to invest in the commodity itself, oil, where you make money when the price of oil goes up in spite of how any of the companies that are involved in its production may fare.

Investors have a natural tendency to favor stocks, and so when you tell them that there will be a big opportunity in oil coming soon, they may want to buy oil stocks or funds that hold them. They usually think that trading oil is something that futures traders do, and are both bewildered and frightened by such a thing.

Stocks in general do have some big advantages over commodities longer-term, but the first thing that we need to set aside to look to profit from this move is the long term. This is a shorter-term opportunity to be sure, and commodities are no place for anyone but short-term traders, and anyone with a plan for anything beyond the short-term has no business in any type of oil asset actually, since the outlook for oil is so dim.

We certainly do not want to count ourselves among the investors who become tricked by dividends. Dividends excite investors generally and especially when they get bloated up by a company’s stock price tanking. There are lots of people who are even borrowing money at unsecured rates such as 6 to 7%, or maxing their home equity line of credit, to buy stocks these days for their dividends, which is pure madness.

Investment firms are peddling these stocks and funds based upon dividends being a source of income, where if the payout is 8% and it costs you 6% to play, this appears to represent an easy 2% profit. This is not only foolish, it’s very dangerous, especially if you are borrowing to buy these stocks.

It’s not even that these dividends aren’t guaranteed, it’s not even the fact that there may be a serious risk of their being cut, it is the risk of losing their capital that stands out the most as far as why this is such a big mistake. This is especially the case with oil stocks, which remain the most terrible type of stock to own and this likely will remain the case for a very long time.

Dividends rise when the price of a stock goes down a lot, and even if they continue to pay these dividends at the same rate, this serves to syphon off profits that are sorely needed to either grow the company or the stock. Dividends are never a good reason to buy any stock and a great rule of thumb would be to never own a stock with even an above-average dividend, and especially not high dividend ones, because these dividends may put some money in your pocket but will cost you more than you gain in lost opportunities for capital accumulation.

We’ve been as bearish as anyone on oil stocks, where we should simply just say no to them and keep saying no, but oil as a commodity is a different animal. The reason why oil stocks are so undesirable is because stocks leverage the future, and the future of oil is not bright at all and nowhere near as much as stocks in growth sectors are.

With futures though, ironically, we’re not really concerned about the future, at least the future more than a few months out. Over the next while, and especially once these countries put down their swords and the world gets over their fears of the most exaggerated health risk of all time by a long shot, the supply of oil will decrease and the demand for it will increase, and that means that the price will be rising, by a good amount at least.

Oil Has Been Beat Up Far Too Much, Which Should Really Excite Us

The big drop in oil prices that we’ve seen lately is very artificial and transient, as artificial and transient as you could ever get with oil prices in fact. This is a perfect situation for us, and while looking to time the oil market is normally difficult enough even for skilled oil traders, the coming opportunity with this is so obvious that we all can take advantage, even those with no trading experience or skill.

There are a lot of other opportunities out there that compete for our investment money, and stocks of course have been pretty beaten up by this, although they have come back by a good amount already. While that train left the station a week ago, it still has some room to travel, but nowhere near as much as the oil train does, which is still very much broken down and waiting for the wheels to start turning again.

While we don’t expect amateur investors, who do not know all that much about investing, let alone commodity trading, which presents a far greater level of difficulty, to open futures accounts and buy oil contracts, as you do need to know a good amount about what you are doing to pull this off very well, even with a bonanza on the horizon.

The bonanza on the short side of oil contracts has been simply enormous, but that ship is almost in the port and does not have that much upside left, and lots and lots of risk. There’s too much risk in investors trading oil at the tamest of times, as your mistakes get multiplied by many times and you can be in a world of trouble if you aren’t good at managing this risk, which involves making this your full-time job at a minimum.

Investors need something that they can just check in the morning or after work, and while you can dial down the leverage with futures contracts to set it anywhere you like, investors prefer something like an ETF instead, things that they already have access to through their normal brokerage accounts.

Investors also aren’t going to be ready to handle the high levels of leverage that futures traders use, although they still should want to use some to at least sweeten the pot enough to make doing this a lot more tempting than just owning stocks. ETFs offer up to three times leverage, as big of an amount that investors should ever wish, and even then, they should confine themselves to situations like this where there is much more upside than downside, where this greater upside can be multiplied.

The ProShares UltraPro 3X Crude Oil ETF is a great choice here, as it moves directly with oil futures prices and is just like trading futures but without the need for a futures trading account. If oil moves up 50%, which is the low end of things, you make three times that and can make a lot of money in a short period without knowing much more than oil prices are too low and have to come up soon.

We might think that seeing oil lose half of its value lately might be a lot, plenty of stocks have lost this much lately and that part doesn’t even stand out. When we look at how far this ETF has dropped though, it is something to behold and gives us a much better idea of the real potential of something like this.

The ProShares UltraPro 3X Crude traded at $75 back in October of 2018. It now trades at 21, not 21 dollars, 21 cents. This represents a selloff of 99.3%, as close as losing it all as you will ever see.

If we only make it back to where we were to start the year, where we were at $21, going from 21 cents to 21 dollars represents a tidy return of 10,000%, multiplying your investment by 100 times in other words. A thousand bucks becomes turned into a hundred thousand, and that’s only if it goes to where it was three months ago. It doesn’t even have to go anywhere near that high for us to make a whole lot of bread.

This should at least serve to turn people’s heads who get excited about a stock making back its losses from the hammering that it might have taken in 2020, where if a stock has lost 50% and goes back to where it was before, you only double up. That’s still pretty nice, but this is the minor leagues, and this ETF plays at much higher levels than this as we can see.

Choosing to do this with an ETF versus trading the contract on your own means that you do not have to worry about margin calls. This is the biggest risk with futures trading, and traders will run for their lives usually before they get remotely close to this, but this requires day trading and not the casual sort that investors partake in.

This ETF can certainly go lower, and that is technically risk, although if we just decide to hang on to it, no matter what happens, our brokers won’t be closing our positions like what can happen with futures trading. It’s an excellent bet that this ETF will be worth quite a bit more than 21 cents a share a few months from now, or even a few years from now, as the combination of the coronavirus and the swashbuckling Saudis involves downward pressure on oil prices of a magnitude you just don’t see, or maybe ever will again.

Oil Has to Come Back Soon, and Come Back Big

This does require that we realize that, just like the Saudis cannot choke their oil economy for very long, the world cannot choke their economies for very long either. Both of these situations being remedied is as sure of a bet as there is in the investment world, and we want more than just even money on this, which is where the 3X leverage comes in.

While we would not want to put our life savings on this, this opportunity is so enormous and unusual that we don’t want to be just using chump change on this either. We also may want to wait a bit, but on the other hand, the iron is red hot right now and we should worry less about it going down a bit from here as how quickly it might rise and see us losing a lot of potential gains while we sit on our hands.

We’re still well away from this crisis being settled, but when you get a sell-off this big, you need to realize that you are not the only one who is seeing value in oil right now, and if you wait for a lot of others to pony up first, the cost of this pony will go up quite a bit. Paying even 42 cents a share instead of 21 cents may not seem like that much, but you’ve just given up a 100% gain by waiting, which is a lot indeed.

If we go down to 10 cents while we are waiting for things to improve, we need to make absolutely sure that we are not tempted to dump it, whether we are prepared to wait or not. This is far too volatile, especially at 3 times leverage, to ever want to be playing this game, and we need to leave this up to the real pros and not pretend we’re traders.

There aren’t many situations in investing where you can say that you don’t care how far down it goes and you plan on hanging on regardless, and this in itself makes this opportunity so deliciously unique. You still will need to have an idea of when to get out, but wherever you do, it’s going to be a lot higher than 21 cents because we likely will never see it this low again in our lifetimes once we put these two things behind us.

This might be the easiest recommendation we have ever made in fact, and this not only has the potential to put any other investment you’ve ever made to shame over the next few months, it’s also as sure a thing as you will ever find. We should find the combination irresistible. The early bird really gets the worm this time.

Eric Baker

Editor, MarketReview.com

Eric has a deep understanding of what moves prices and how we can predict them to take advantage. He also understands why so many traders fail and how they may help themselves.