You are viewing extempore

Jan. 29th, 2009 @ 09:22 am finances and oil
Thanks for all the stock picks. Having already been killed on USO and more recently DIG, COP, and a number of others, my natural inclination (you may recall I'm a gambler at heart) is to double up on everything. That would really stick my neck out, but hey, retirement is overrated. Here's an article "Oil Rises, Oil Falls" supporting that move. Someone talk me out of it.
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From:reubenf
Date:January 29th, 2009 06:09 pm (UTC)
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Martingale on the stock market?
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From:extempore
Date:January 29th, 2009 07:08 pm (UTC)
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Exactly. Of course that's how you end up faking your death by crashing your plane into the everglades or something, but hey, that's a possibility we all think about every day.
From:matchesmalone
Date:March 1st, 2009 03:43 pm (UTC)
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Haven't you necessarily effectively done that? You've isolated yourself and your family in a city/state that doesn't wish to acknowledge you exist in the first place....

Also wondering if you're going back on the tour, as a result....
From:lowwall
Date:January 29th, 2009 09:07 pm (UTC)
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Have you ever stopped to figure out your real return on your investments and compared it to an appropriate passively managed benchmark? I guess you have money to burn, but I'm sure you could find a more fun and useful way to dispose of it.

The hardest investing lesson to learn, especially for intelligent and/or accomplished people, is that future prices of publicly traded instruments are not predictable. In other words, investing is not a game like poker in which skilled players have a positive EV. It's a true gambling game like roulette. The difference is that the investor is the house, so the longer you stay invested, the greater the likelihood of coming out ahead. The reason for this is simple, current prices are set by the collective action of a whole bunch of smart people. There are certainly a bunch of idiots in the collective, but they usually don't have enough money to push things very far, it's the professional players like endowment, pension and mutual fund managers really determine prices.

Note that this doesn't mean the current price is correct in any definable way, just that tomorrow's price is equally likely to be down as up (actually it's slightly more likely to be up since that's the long term market trend). Unless you have (illegal) non-publicly available information, you are thus not going to outguess the current price at a rate any better than chance. And since every attempt to outguess it costs money in terms of trading costs and possibly taxes, you end up with something well under 50/50.

If I can take this metaphor a bit further. Since you are the house, you want to do a couple of other things. Diversification across asset classes lowers your variance, just like hosting multiple types of games. Also like the house, the take is reduced by the amount you have to pay to keep the game running, so do what you can to reduce fees and expenses. (The metaphor kind of breaks down here since casinos have to spend money to attract the punters, but you don't get anything back for your costs.)

The lesson from all of this is to make your money from your job or other interests and "settle" for market returns with your investments. Do this and you'll outperform around 80% of all "investors" at a cost of a few hours per year.

BTW, this only applies to publicly traded stocks and bonds over which you will have no control of the underlying business. That's why Warren Buffet does not provide a counterexample, buying and funding entire businesses (or cornering the silver market) is a entirely different kettle of fish.

I'll leave you with a reading assignment. These are the papers from the leading researcher into how real investors perform. One of his major findings is the more someone trades, the greater his underperformance.
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From:extempore
Date:January 29th, 2009 10:41 pm (UTC)
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I know that stuff -- it's what I tell people who sit around trading all day. I've also made substantial fortunes by not paying much attention to it. I mean, maybe AAPL was worth 2% or so of what it is now back when I bought a ton of it, but I applied some publicly available knowledge. Maybe it was equally likely to go up or down. Maybe. I'm going to need a lot more evidence before I conclude that I can't beat the wheel.
From:lowwall
Date:January 30th, 2009 12:01 am (UTC)
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Well that's standard objection #1, "But I made a killing on x". Which is why I opened with "Have you ever stopped to figure out your real return on your investments and compared it to an appropriate passively managed benchmark?" If you haven't performed this exercise, then you don't have any idea if you have actually beaten anything.

You see, people consistently emphasize their good calls and forget or downplay the bad ones. You might be interested in reading up on behavioral economics, a good starting point (despite the awkward title) is "Why Smart People Make Big Money Mistakes And How To Correct Them: Lessons From The New Science Of Behavioral Economics" by Belsky and Gilovich. I haven't read it, but based on his past work, Jason Zweig's take in "Your Money and Your Brain: How the New Science of Neuroeconomics Can Help Make You Rich" is probably even better. Or you can go right to the heavyweights: Richard H. Thaler or Daniel Kahneman and Amos Tversky.

If it turns out you have consistently outperformed the relevant benchmark, then maybe it is worth taking the flier. But even in this case, you need to be realistic about the limits of your superior knowledge. For example, if you've made consistently good calls on consumer tech companies, does that really give you insight into oil prices?

BTW, standard objection #2 is "But what about Warren Buffet?" So that's why I threw that in.
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From:extempore
Date:January 30th, 2009 12:43 am (UTC)
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Yes, you haven't said anything here I haven't known for a long long time. I'm going to keep doing what I do, which entails long periods of leaving it alone punctuated by short bursts of realignment. And yes, I have destroyed any passive benchmark. I'm not cherrypicking my investment choices; AAPL was by far my biggest position, and there aren't a bunch of losers to offset it.
From:lowwall
Date:January 30th, 2009 04:06 am (UTC)
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By far your biggest position? I guess there's no point in mentioning non-market risks.

But if you are so good at this, why have you "already been killed on USO and more recently DIG, COP, and a number of others"? And why are you asking us for tips anyway? With your apparently verifiable record of success and borderline fame, you could have a very profitable sideline as a newsletter writer.

If you really want my .02 on this... Oil and commodities will come back, but not until the world economy picks up, which could take a year or two. So if you have some spare cash and patience, why not go long on the sector? But not with leveraged plays, volatility and time both work against you when you take on leverage and neither of those look to be in your favor right now.

The only things I've done over the last couple of months are to take 10% from my high quality bond allocation and use it to restock my equity holdings and dip a toe into junk bonds for the first time. I make these sort of changes only when it seems there has been a substantial overreaction in the market, in fact the only times I've adjusted my allocation since I started investing in 1996 was in 1999 (adding EM, microcaps and bonds) and 2007 (increasing my bond allocation from 15% to 25%, it's now back to 20% if we include the junk). All of my holdings are in index funds, ETFs, or Vanguard bond funds that are index-like (low cost and low turnover).
From:mosch2000
Date:January 30th, 2009 08:40 am (UTC)
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> By far your biggest position? I guess there's no point in mentioning non-market risks.

At one point AAPL was by far my largest position as well. What happened was essentially this:

It was 2002 or 2003, and I'd bought an iPod, a new Apple Laptop, and was using OS X. All of these seemed like absolutely fantastic products, and the sorts of refinement that were occurring on each revision gave me confidence in the direction they were going. As such, I decided I was going to buy and hold a moderately sized position in AAPL.

I'm young enough, and the position was small enough that I wasn't really concerned if I was wrong. I wanted to buy and hold this stock.

And the stock rose more than 1000%, thus making it so AAPL was by far my largest position. But all along the way, I occasionally found myself wanting to take profits, to be a tad risk-averse... but then I'd look at the company, and I'd realize that nothing about my analysis had changed. That I still wanted to buy and hold it.

It's not that I'm unaware of risk, it's that even after AAPL had grown to dominate my portfolio, I felt that my analysis was correct and that my life would be helped more by the win than I would be harmed by the loss.

After all, even if AAPL went to zero before I could sell it, that'd just leave me about where I would've been anyway, had I listened to the advice of people who argue against making unique investment decisions.
From:lowwall
Date:January 30th, 2009 08:51 pm (UTC)
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Even though the standard mantra is that higher risk = higher expected return (note the word "expected", the return doesn't always show up), you are not compensated for taking on non-market risks. The non-market risks here are collectively known as single-company risk.

Which is a long-winded way of saying, you were taking a huge risk on things like Jobs' health. It paid off for you here. But if you keep making large bets on single companies, you will eventually get burned - no matter how right you were about conditions when you bought the stock.
From:mosch2000
Date:January 30th, 2009 08:20 am (UTC)

Beating the Market...

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I firmly believe that intelligent, informed, objective people will occasionally notice market irrationalities, and devise ways to successfully exploit them. That said, doing so takes great care, and requires some significant education, intelligence and knowledge.

After all, a person who is a top achiever at basically everything they've put their mind to is a person who can learn enough about risk, markets, economics and pricing to at least occasionally find and exploit the markets.

Speaking for myself, my portfolio returns went through the roof when I stopped assuming that I couldn't beat the markets. (Though to be fair, I've coupled that with some substantial formal study in finance and economics.)
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From:patrissimo
Date:January 30th, 2009 03:28 am (UTC)
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Oil seems very low to me. I'm long, but it's a small position. It seems awfully likely to jump when the world economy recovers, but I'm concerned that may take awhile.
From:mosch2000
Date:January 30th, 2009 08:52 am (UTC)
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I've actually flipped a couple of my positions recently. I used to be short on SLX, UGA, GM and F.

I've since gone long on SLX, X, F, TM, OIL and GE.

Granted, all those positions still add up to a fairly small portion of my portfolio, but I just enjoy making some of my own decisions, rather than trusting it all to the efficient market hypothesis.
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From:dmorr
Date:January 30th, 2009 04:05 am (UTC)
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I recently went long on oil for what is a fairly significant (for me) position. So I definitely agree. Especially since I don't think OPEC is going to let the price slide much from where it is.
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From:michaelsullivan
Date:January 30th, 2009 07:04 pm (UTC)
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I can certain imagine oil going lower in the near term, but it's hard to imagine it not going very high again within 5-10 years, unless one of two things happens:

1. This depression really gets as bad as/worse than the 30s and we get negative worldwide economic growth for more than a few years.

2. some new fuel or conservation tech development that covers a substantial portion of oil's current market appears within that time frame.

We are at peak oil now. Unlike the alarmists, I don't think that means we need to start learning how to subsistence farm. But it does mean that the price won't be going down long term unless demand goes down long term.

I rate the chances of 1 as around 15-20%, and the chances of 2, conditional on ~1 as somewhere around 10-15% (pretty close to zero otherwise). Might want to sterilize those numbers before using them for anything too sensitive, but that leaves me thinking that long oil is a good idea, to the extent that long anything is a good idea.

But then, if nothing long turns out to be a good idea, I'm not so sure being short will make a lot of difference in my end-state utility. Your greater wealth may change that calculus, but my future economic utility is pretty well dominated by things like having a functional modern economy to work/buy/sell in.
From:henryclay
Date:February 2nd, 2009 10:46 pm (UTC)
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I am Bullish on the following asset classes:

Mid cap equities
Angel investing

I also recommend a NNTaleb like strategy of buying out of the money puts on a number of companies across a number of industries (It is a little more complicated than that.)
From:henryclay
Date:February 2nd, 2009 10:54 pm (UTC)
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Regarding Oil, I'd like to hear more arguments for why the price will stay low. It seems like we need a technological advance that can be retrofit to our existing infrastructure. Still, I can see prices staying low for a while. I think once prices start to rise >20% they may continue to go up as this will prompt more companies to take more aggresive hedging strategies against the price, which they may not be doing now. "Speculators" and other persons may start piling money in as well. But, I think the price may also peak around 60-80 (who knows how long from now) and stay there for a while (who knows how long)
From:howardtreesong
Date:February 4th, 2009 10:39 pm (UTC)
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I have a hard time reading articles like that with a straight face after reading Taleb -- at least, the parts that suggest that historical narratives bear on the oil pricing analysis (prices go up a lot in years after they go down, suggesting that the future will behave the same way) going forward. This is very likely in the category of observations that you've known for a long, long time.

That said, I have a hard time imagining oil staying low in the mid-term. But that's based more on the portion of the article suggesting that capital expenditures to come up with more oil are going to start dropping if oil prices stay where they are.
From:rosenblumr
Date:February 5th, 2009 12:37 am (UTC)
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Well on Taleb, It is not clear to me that he would be buying out of the money options in the current market. His argument is that the market tends to under price the occurrence of the rare event (the out of the money option). And, although I have not looked at option pricing closely in a couple of months, the market is now likely OVERPRICING risk. Even if it is not overpricing it, it is clearly less underpriced, and thus less of a value.

As to oil, it does not appear that oil use is going away anytime soon. The ipod, is more likely to become obsolete without warning than is oil (see the Sony Walkman). Until there is a solid Oil replacement, too many economies depend on it. Where it is certainly possible (although I think unlikely) that we develop an oil substitute BEFORE the economy turns thus reducing Oil's marginal demand permanently (or close to it), I have to think it is more likely that oil in 24 months is at 60 than 20 (roughly a 20 move way). In order to account for time value of money, I still think it substantially more likely that oil is at 60 than 25 (or 65 v 20).

IN other words, I have no idea if I will be correct, I just think the upside outweighs the downside by enough to justify the bet. A small bet, but a bet nonetheless.
From:henryclay
Date:February 5th, 2009 11:22 pm (UTC)
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On Taleb all of your points are completely valid. It is likely that the pendulum has swung too far in the other direction and the market is overpricing risk. But, I think this is mostly applicable to certain markets and not necessarily equities as a whole. I also think that risk will still be fundamentally underpriced as it relies too much on the past. We aren't really taking into account the likelihood of rare events any better, we are just scared shitless about banks and other troubled industries failing. We will soon mostly forget about the past and the pendulum will start swinging back.

I also believe that technology is creating network effects that will disrupt the extreme distributions that reflect market share in most industries. Individual companies across still successful industries will continue to fail at an increasing rate.

Additionally, I am proposing an far out of the money options strategy as an "asset class" that most people should be diversified to. It is not a get rich quick awesome investment based on the current situation (Which is what this thread is about so that's my bad.)

Regarding Oil, we now have two more smart people who think Oil is going up. Is no one else bothered by the apparent consensus that Oil is going up? Who is selling all the oil that you are buying? i.e who is the loser?
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From:extempore
Date:February 6th, 2009 12:29 am (UTC)
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Fuck yeah, someone's bothered, that's why I asked you guys to talk me out of it.
From:rosenblumr
Date:February 6th, 2009 04:40 am (UTC)
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I dont think I am in disagreement with anything you have said. Right now risk is priced very differently than it was, say, 1 year ago. At some point in the future it is likely to revert back to the pricing models of old. Seems to be human nature.

I cant say I ever thought of holding out of the money options as an asset class, but I think I like the idea. Holding numerous out of the money options is, in normal market conditions, the opposite of a get rich quick scheme. Most of the time you make nothing. But it is a far better hedge than, oh I don't know, gold.

Who is selling the Oil? Who the hell knows. Speculators? They did seem to run it up (dont get me wrong I am VERY pro speculation). Or perhaps people that own it that need cash, or bought futures on spec but cant take delivery. Still it seems to cost more than the current price to get it out of the ground, so either the price goes up, or we all stop using oil. I am pretty sure the former is more likely than the latter.

From:mdh400
Date:February 6th, 2009 02:32 pm (UTC)
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I guess the argument for low oil prices might look something like this:

Although oil prices appear quite low, by historic standards they’re actually pretty high. Inflation adjusted historic prices have been reasonably steady at $20/b, apart from a couple of shocks. So a simple argument would be ‘this is just another shock and oil prices will revert to the mean just like every other commodity has throughout history’.

“But oil is different!” people say. “It’s running out, and demand will increase forever”. But are we running out? People have been saying this for years and we keep discovering more. It’s not as easy to find, but there’s definately a lot of oil out there. For instance, we have no idea how much oil is in the middle east, because no one has bothered to look. Oil was so easy to find there and so plentiful that they simply dug a hole in the ground and out it came. There are a lot of places they’ve never looked because the financial incentive wasn’t there. Recently they’ve discovered huge fields off the coast of Brazil and China. And then there’s oil sands – Canada has as much oil as Saudia Arabia. The recent high oil price has lead to a new wave of discoveries, and the higher oil price justifies makes their economic extraction possible. An article in the economist from 99 (not that long ago) worries about the effect of $10/b oil on middle east economies. If exploring for north sea oil and then drilling for it is profitable at those levels, imagine what’s profitable at 30, 40 or $50/b! FWIW the tar sands are profitable at about $60/b, so anyone forecasting a long term price above this level has got to have pretty optimistic assumptions about future consumption.

Things don’t look good in the near term either. At $140/b oil companies were prepared to invest huge sums of money in oil production, at projects that might be profitable at, say $60/b. These will come online in the next few years. The problem is that the marginal cost of producing oil in these is very much lower than $60/b, as so much of the cost is fixed. So there is still an incentive to produce as much as possible when production comes online. If the excess demand isn’t there in a few years time, oil prices currently look high.

I’m not necessarily bearish on oil (I’m just arguing for you, Paul) but people seem to completely disregard basic economics when considering oil (extraordinary profits attract investment until excess returns disappear). Peak oil will occur – it’s inevitable. But I doubt it will occur as soon as people think.


Economist article http://www.casi.org.uk/discuss/1999/msg00181.html
Historic Oil Prices http://www.wtrg.com/oil_graphs/oilprice1947.gif
From:henryclay
Date:February 6th, 2009 10:05 pm (UTC)
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You touch upon some interesting points. Aside from middle east economies, I think both Venezuelan and Russian national budgets account for Oil selling at 60-80. (I have no analysis, just throwing it out there)

Also, I'm not really sure how anyone could accurately price tar sands as the US and others gave out uber tax credits starting in the 70's (which led to many years of litigation on the definition of a tar sand as the oil companies collected billions)
From:mdh400
Date:February 6th, 2009 03:37 pm (UTC)
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I hadn't even bothered to look at this. To put some of the numbers in perspective, current global oil reserves are estimated at 1.2tr barrels - there are 1.6tr barrels of oil shales in the USA alone, economically extractable at around $30/b.

http://en.wikipedia.org/wiki/Non-conventional_oil
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From:extempore
Date:February 6th, 2009 05:43 pm (UTC)
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I'm pretty sure $30/barrel is pure fantasy, at least with current technology. If anybody has produced meaningful quantities at that price it's news to me.
From:mdh400
Date:February 6th, 2009 06:27 pm (UTC)
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It is at the moment, which is why a barrel of oil today trades at ~$40/b, but you have to pay $70/b in 2012. The markets are pricing in higher future prices because of current high costs of economic extraction. Petrobras (brazil) estimates its deep sea activities are profitable at $65/b currently. But I'd be amazed if these costs don't come down significantly with economies of scale. They've also had to pay top prices for workers, rigs etc. during the boom years.
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From:shandrew
Date:February 6th, 2009 06:58 pm (UTC)
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As with most optimistic estimates, that number is probably based on predicted trends in technological improvements in extraction, and is only marginal pricing for the portions that are easiest to extract.

As a substitute for oil, alternative energy may be an interesting investment. In the short term at least, alternative energy tracks oil since it becomes more profitable when oil prices rise.

I'd be wary of investing in any sort of commodity in the long term except as a hedge. People who study the industry and the numbers 80 hr/week are still not buying more than selling at these prices (of course many of these people were buying at 140. and of course, some were selling at 10 in the 80s).

With stocks, you can count on generally long term positive returns since people and companies tend to improve and make more money as time goes by. With commodities, there is no fundamental basis for long term increases in price. You are betting against technology. Furthermore, with a commodity like oil (unlike say, gold), the long-term upside is low because of substitution effects.

Disclaimer: I haven't studied the numbers in a long time, and those are what really count.
From:howardtreesong
Date:February 6th, 2009 04:31 pm (UTC)
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I don't think that agreement among some folks on Paul's blog reflects a broad market consensus, with all due respect to those here. Putting a finer point on my opinion, I do think that oil is going to go up. But I don't trust my opinion at all and don't think that I can in any way accurately predict what's going to occur with it. I don't think anyone can: how many of you would have said last April that oil would be $100/bbl cheaper in ten months?

I still haven't gone out and bought a pile of dried fruit, MREs, and ammunition. Am I an utter wing nut for thinking that I probably should?
From:henryclay
Date:February 6th, 2009 09:56 pm (UTC)
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Well Howard, You can assign a confidence of 1% to your prediction but you still predict Oil going up as opposed to down. Whether or not you act on it is largely irrelevant as this is simply an indicator of your confidence, which you are freely assigning a very low number to. Just as RR above is assigning a low confidence to his prediction (maybe 55%), he is still predicting Oil to go up as are most people here.

I do agree that people on this blog probably share similar biases but I'm not really finding many people anywhere that are putting forth strong arguments for current or lower oil prices. And, in any situation where the consensus is so lopsided it raises a red flag for me. Of course, in a free market, people thinking something has more value actually can increase its value and price so everyone here could be right.
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From:shandrew
Date:February 7th, 2009 03:24 am (UTC)
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I just read the article. It's well written and interesting, compared to a typical blog post. However, it is more of a "I've already chosen my viewpoint, and I'm going to present only evidence that supports it" type of article rather than an article which does not begin with a bias and presents fair evidence.

Dismissing speculators as a major reason behind the wild spikes in oil price in 2008 cannot be done so lightly; it's not just media idiots who say speculation played a big part, and being on fox news doesn't necessarily mean it's wrong. Economists such as Alan Greenspan think that speculation was a big factor. Some funds were making huge heavily leveraged bets on oil and ending up bankrupt when their timing on oil contracts and derivatives coincided with drops in oil prices.

The bit in the article about climate change is the clearest example of failing to provide unbiased data. I won't even get into the "NASA" "virtually assuring" BS, but even if his global cooling prediction were true, he completely ignores the fact that a global cooling trend will translate into lower energy use for well, cooling! Actual scientific research predicts that in climate change scenarios the overall global change in total heating plus cooling energy usage is small. The amount of oil actually used directly for heating is small and diminishing (why use increasingly expensive oil heat when electric is cheaper). I could go on but i've made my point.
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From:awesomescampi
Date:February 11th, 2009 05:54 am (UTC)
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From:henryclay
Date:February 11th, 2009 04:52 pm (UTC)
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Or perhaps there are some interesting arbs to be done. (nice article btw)
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From:ezrastiles
Date:February 13th, 2009 03:35 pm (UTC)
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I love oil articles that point out how new oil production plummeted when it went from super high prices in the 1970s to super low prices in the 1990s. It's because we are running out of it, right? Because in any rational capitalistic market entrepeneurs would be rushing to find new oil fields as it's price plummets;)
From:matchesmalone
Date:March 1st, 2009 04:17 pm (UTC)

In your situation...

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I would say cash is king. If you can make that happen for you, that's your call.

Alternatively, I once heard someone say, “Buy land. They don't make it no more....”
From:lowwall
Date:March 3rd, 2009 09:56 pm (UTC)

1 month later

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USO, DIG and COP are off another 13% to 34%. If you did double up, I seriously hope you've been practicing bankroll management and set aside enough in cash and bonds to live reasonably comfortably whatever may happen to your speculative plays.
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From:extempore
Date:March 3rd, 2009 10:39 pm (UTC)

Re: 1 month later

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I appreciate your worrying about me, but it's really not necessary. Also, living comfortably is overrated.
From:lowwall
Date:March 4th, 2009 07:42 pm (UTC)

Re: 1 month later

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living comfortably is overrated

Makes me wonder if you have ever lived uncomfortably. But I guess it depends on your definition of comfort.

Anyway, since I have your attention. How about a new blog? If you're short of topics, I've got a 3-month-old son, and I promise I'll give your parenting thoughts more respect than your stock picks. I've tried no TV, but my wife has overruled.
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From:extempore
Date:March 5th, 2009 11:52 am (UTC)

Re: 1 month later

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Makes me wonder if you have ever lived uncomfortably. But I guess it depends on your definition of comfort.

Yes, I didn't mean that I'd enjoy having to fight for my supper. I was referring to the fact that never having to work again is not necessarily optimal if one is attempting to maximize happiness.

I'm not short of topics, just time. Eventually I will post about what I've spent the last year or so doing.
From:henryclay
Date:April 13th, 2009 06:24 pm (UTC)

Final thoughts on oil

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1. I assume that (the price of) oil is tied up with the global macro economy, so to a large extent, a bet on oil is a bet on the global macro economy.

2. I assume it will be at least 2-3 years before we possibly experience any meaningful recovery.

3. I assume that consumer behavior + increasing (but still nominal) fuel efficiency gains will mostly offset increases in oil demand in the U.S. and other rich/developed countries, (for the next several years.)

4. I assume the price of oil will rise on average 10-15% per year.

(I am completely discounting major technological breakthroughs, which are unpredictable but not unlikely)

Given these assumptions I don't believe oil is a good bet. If we consider inflation + opportunity cost + high futures premiums, betting on oil seems like a poor use of our money. Sure, it might be marginally +EV, but even if the price rises to 200 over the next 10 years, I don't see sufficient opportunity to warrant an investment.

(I concede that the funds Paul is invested in seek to capitalize on short term spikes in the price of oil, which may happen from time to time, but for these to be worthwhile I think we need more volatility that I expect.)

Flame away clingy oil lovers.