Shift Investments to Oil? Part 1

I've been thinking a lot about what to invest into next, from the point of view of "where can I make the greatest amount of money (both short-term and long-term), with minimal risk." And I'm coming to the conclusion that the place to be is: Oil.

Commodities vs Stocks:

From the risk perpective, I've been looking at ETFs comprised soley of commodities -- that is, the commodities themselves (e.g. oil, gold, corn, wheat) that trade on the futures exchange, not stocks of companies that are involved with such commodities (the latter of which most commodity-related ETFs actually hold, e.g. DIG). The risk of a further drop in the stock market is quite possible, and it's even more possible that after a brief rally, the recession/depression in the U.S. keeps the markets from gaining that much for the next few years. We've already seen gold stocks lose 50% of their value while the price of gold has gone up, so in a volatile market in the middle of a recession, stocks are a risky place to be. The prevailing consensus is that most commodities can only go up in the long term, especially energy and agricultural related commodities due to the double-whammy of increased consumption (due to world population increases and the rapid development in countries like China and India) and declining production (running out of resources, getting harder and more expensive to grow or extract resources).

Now, unless you're buying actual futures contracts, which often have a leverage of 10:1, it used to be that stocks related to the commodities would go up by a much larger percentage than the percentage increase in the commodities themselves. So while I'm interested in commodities, I still want something that will increase a lot when the commodity goes up. We'll get to this later...

Which Commodity?

While Sprott and others believe gold will go to $2000, there seems to be some risk that that may not happen, or it may take a while. I've noticed the guys at Sprott seem to talk more about energy and oil than gold. I'll be pointing out some quotes from the recent Sprott Webcast that talk about the Oil situation a little later in this post. There seems to be less downside risk in Oil to me, but maybe I just haven't read enough views about how bad the current and upcoming (short-term) decrease in demand could affect things and how low oil could go. Then there are other commodities, such as agricultural ones, which don't get much attention and which I honestly haven't looked into that much. World population and increased standard of living in China in India are going to mean we'll need more and more food (whether to feed the people or to feed the animals that the people will eat!). It's hard to say which commodity has the most potential and least risk, but lets see what's happened with some of the commodity ETNs the last little while...

Commodity ETN potential performance:

The only 2x leveraged pure commodity ETFs I know of are the ones from from Deutsche Bank (who is known for their PowerShares series of ETFs). Their pure commodity plays are actually ETNs (Exchange-Traded Notes), which don't seem much different from ETFs to me. Their list of commodity ETNs can be found here. They haven't been around that long, but most began trading just before the peaks in commodities that occurred around March 2008 or end of June 2008. Let's look at the difference in price now from their peak, in order to see the potential gains we would make if they went back to their peak price...

Gold 2x ETN: DGP (comprised of Gold futures):
- Current price: $12-14 Peak Price: $28 Difference: 2x

Agriculture 2x ETN: DAG (comprised of corn, wheat, soybeans, and sugar futures)
- Current price: $8-11 Peak Price: $29 Difference: 3-4x

Base Metals 2x ETN: BDD (comprised of Aluminum, copper, and zinc futures)
- Current price: $7-8 Peak Price: $28 Difference: 4x

Oil 2x ETN: DXO (comprised of Oil futures)
- Current price: $4-6 Peak Price: $29 Difference: 5-7x

Commodity 2x ETN: DYY (just a mix of everything, specifically: wheat, corn, oil, heating oil, gold, and aluminum)
- Current price: $8-10 Peak Price: $35 Difference: 4x

So any of these look pretty good -- a chance to make 2 to 7 times your investment if the commodities go back to their peaks. Now you could argue that that scenario is unlikely, as the commodity boom was fueled by a lot of speculative traders. However, Sprott and others are arguing that the commodity boom will continue, especially with oil and gold having nowhere to go but up.

Looking at the above numbers, we can see that oil has had the greatest drop, and maybe the greatest potential to reach it's previous highs again. Can you imagine making 500% (6x) your investment in a few years if oil hits the $140's again? What is the risk? Could Oil go back down to $30 or $20 again?

Anyway, that's all for this post, which just touched on the potential for gains in the commodities -- specifically oil. In the next post, I'll mainly talk about what Eric Sprott talked about in the latest webcast, and then look in more detail at investing in DXO.