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Stage 2 Oil Investing

Posted August 15, 2016 at 7:47PM

Oil prices have rebounded big in August.

WTI is up 1.02% today to $45.53. Brent is up 1.07% to $48.04. Furthermore, front-month WTI is now up versus a year ago for the first time in a year. The contract was up 44 basis points over last year.

This is bullish, as it means options traders, the so-called “smart money,” are betting on higher oil prices into the fourth quarter.

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This is important because higher oil prices year-over-year will boost inflation gauges, impact the trade deficit, and have implications for certain sectors of the stock market.

But perhaps the most important impact will be sentiment. It could be that the downtrend will break if we hit $47 on WTI (see chart) and small-cap oil stocks will launch. But even if we get a sell-off to $44 or even $41.75, there will be no panic. The massive fear of oil price Armageddon is over.

Cycle of Oil

Oil is perhaps the most cyclical sector. Boom follows bust like summer follows spring. I remember investing and winning big after the oil bust of 2002–2003. No one wanted to own oil companies then, but as has been proven time and time again, you make big money when you buy low. Range Resources Corp. (NYSE: RRC) went from $3 a share to $95, Petrobras (NYSE: PBR) went from $3 to $75, and ExxonMobil (NYSE: XOM) went from $20 a share to $100.

Here are the stages of the oil cycle:

Stage 1: This is where we are now at the bottom of the cycle. There is too much oil supply, which results in low oil prices. Low oil prices mean that investment in new projects withers. Prices are also low, which stimulates demand. It should be noted that big trucks are now selling like hotcakes. F-150s just hit a record for total sales and were up 9.6% over last year.

Stage 2: Demand grows faster than supply, leading to a tightening supply/demand balance. Oil prices begin to rise.

According to the EIA, we are just about to enter Stage 2:

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Stage 3: Rising oil prices mean oil companies start making money, and they ramp up investments in new projects. The higher prices rise and the longer they remain high, the greater the investments. New oil plays become economical, and new oil companies are formed. There is a huge multi-year lag time for stage three.

Stage 4: Higher prices curb demand growth, and new projects begin to come online. Production growth begins to outstrip demand growth. We saw this in 2013–2014.

Stage 5: Prices collapse, and the oil industry contracts as capital expenditures are slashed. We return to Stage 1. The cycle is complete.

It is time to start putting your money in small-cap oil companies like Range Resources was in 2002 — it's a $6.5 billion company now — as it will be the little guys that return the most money when Stage 2 hits in earnest. Heck, XOM is down only 13% from its all-time high. It's not exactly a diamond in the rough.

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OPEC Meets in September

If you want a short-term tradable catalyst, look no further than the next OPEC meeting.

In an August 8 statement, the cartel said higher oil demand is expected in the third and fourth quarters. OPEC president and minister of energy and industry for Qatar H.E. Dr. Mohammed Bin Saleh Al-Sada said the recent decline in prices is temporary:

"These are more of an outcome resulting from weaker refinery margins, inventory overhang – particularly of product stocks, timing of Brexit and its impact on the financial futures markets, including that of oil." Increased crude oil demand in the third and fourth quarters, augmented by winter in the Northern Hemisphere, and a decrease in supply suggests prices will bounce in the second half of the year, he said.

Still, OPEC has scheduled a meeting September 26 through September 28 in Algeria during the 15th International Energy Forum, ostensibly to reconsider a production freeze.

Prediction: Oil prices rise into the late September OPEC meeting. This, in turn, will drive up prices of small-cap oil stocks. The subsequent sell-off will set a higher low for the uptrend started in January.

We are at the beginning stages of a new secular bull market in oil. I encourage you to find well-funded, solid resource oil companies. They are giving them away right now for pennies on the dollar. Here are three.

Lock and load,

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Christian DeHaemer

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Since 1995, Christian DeHaemer has specialized in frontier market opportunities. He has traveled extensively and invested in places as varied as Cuba, Mongolia, and Kenya. Chris believes the best way to make money is to get there first with the most. Christian is the founder of Crisis & Opportunity and Managing Director of Wealth Daily. He is also a contributor for Energy & Capital. For more on Christian, see his editor's page.

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