Oil hits 2year high

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Oil prices jump to 2-year-high

December 22, 2010

NEW YORK — Oil prices jumped above $90 (U.S.) a barrel Wednesday to settle at that level for the first time in 26 months as a third straight weekly drop in U.S. crude inventories and cold weather on both sides of the Atlantic spurred pre-holiday buying.

U.S. crude stockpiles fell 5.3 million barrels last week, bringing the past three weeks’ declines to 19 million barrels, roughly equivalent to one day of U.S. fuel consumption. It was the biggest three-week drop since 1998.

Companies have drawn down inventories for year-end accounting purposes, analysts said.

Also, U.S. data showed the American economy picked up in the third quarter, signaling a more solid pace of recovery and an improving appetite for oil.

A Reuters poll released Wednesday showed a surge in fuel demand in the fourth quarter sent 2010 demand growth to near record levels, adding support to prices in recent weeks, with further increases expected in 2011 as the global economy improves.

U.S. economic data released Wednesday came in mixed, with gross domestic product growth revised upward to an annualized rate of 2.6 per cent from 2.5 per cent, below economists’ expectations and reflecting higher than previously estimated inventory accumulation.

Data also showed sales of previously owned U.S. homes rose in November.

U.S. crude for February delivery settled 66 cents higher at $90.48 (U.S.) a barrel, the highest closing price since Oct. 3, 2008. It earlier touched $90.80.

Analysts now think crude oil’s next target price is $93.05.

In London, ICE February Brent crude gained 41 cents to $93.61 (U.S.) a barrel.

“With two days to go until Christmas Eve risk markets have ignited the afterburner, reinforcing one more time the all-pervasive mantra throughout 2010, ‘What crisis?,”’ JP Morgan analysts said in a note.

A Reuters poll of more than 70 economists this month forecast U.S. GDP to rise 2.7 per cent in 2011, up sharply from 2.3 per cent in a November poll.

With 2010 demand showing the biggest gains since 2004 and expectations of a modest increase in 2011, the Organization of the Petroleum Exporting Countries could be pressured to open the taps next year, another Reuters poll showed.

The poll of 12 top oil-tracking analysts showed that oil demand this year had recovered far faster than anyone predicted early in 2010 and, while growth is expected to slow in 2011, it will still reach a new all-time high.

This year “turned out to be a year of recovery, with economic and oil demand growth clearly beating expectations,” David Wech at JBC Energy in Vienna said. barrels per day next year, OPEC could have to increase output by 800,000 barrels per day to keep pace with demand, the poll showed.

OPEC met this month and agreed to hold oil output at current levels, even as prices move to the top of the preferred range flagged by many members.

While kingpin Saudi Arabia said it favoured a price range of $70 to $80 (U.S.) a barrel, other members, such as Kuwait, pegged $90 as a preferred top.

Ministers from the Organization of Arab Petroleum Exporting Countries, which includes OPEC members such as Saudi Arabia, Algeria and Kuwait, will meet for two days starting on Friday.

Oil found support from forecasts for cold weather in northern Europe and the United States, with U.S. heating oil demand expected to average 4.6 per cent above normal this week.

“Probably what’s been the bigger factor with price has been the weather. It’s cold in Europe. It’s cold in China. And that’s pushing spot demand,” said Mark Kellstrom, an analyst at Strategic Energy Research and Capital LLC in New Jersey.

AccuWeather.com expects temperatures in the U.S. Northeast, the world’s largest heating oil market, to average mostly below normal for the next week, with slightly milder readings late this month.

In Europe, fresh snow forecasts threatened to prolong chaos caused by a cold snap, with airlines and rail networks struggling to restore normal services.

Pescod Plus The Little Book of Commodity Investing

John Stephenson, author of The Little Book of Commodity Investing and a portfolio manager with First Asset Investment Management in Toronto, to tell us why commodities are booming and what investors should do about it.

Many commodities have had huge gains already. Isn’t it too late to jump in?

The average length of a commodity cycle is 20 years and, even accounting for the rise in commodities at the start of 2000, we are at most four innings into the rally. The average mine takes the better part of a decade and more than $1-billion to bring into service, which is why the cycle is so long. What’s more, when commodity prices are high, manufacturers have difficulty passing on these raw material increases in their finished products, so their margins and stock prices tend to suffer. Since rising raw material prices are inflationary and higher interest rates tend to follow higher inflation, bonds suffer when commodities zoom. Commodities zig when bonds and stocks zag, so if you're not considering commodities, why not?

What’s the biggest factor driving prices higher?

In the long term, all that matters for commodity prices is supply and demand. To understand demand is to understand China, which is the engine of demand growth. After more than two decades of underinvestment in commodity production and [then] the global financial crisis, supply is nowhere to be found. Copper inventories on the London Metal Exchange represent just eight days of global consumption – a very tight market.

During the 1960s and 1970s, around 75 million people entered the global middle class in Europe, Japan and North America. This time around, hundreds of millions of people in Asia are entering the global middle class while the supply situation is way worse. Prices will go higher and stay higher for longer than anyone suspects. Eventually, supply will adjust and demand will be satisfied and the bull market in commodities will be over – it just won't be any time soon.

What’s your favourite commodity?

Oil. It's a miracle fuel that powers your car, buses, airplanes and is used to make perfumes, plastics and other everyday items and it's cheaper than orange juice on a volumetric basis.

Least favourite?

Natural gas. We have way too much of it in North America and U.S. producers are drilling not because it makes economic sense, but to retain their land base. With no producer discipline, prices are likely to remain in the basement for the foreseeable future.

What’s an appropriate portfolio weighting in commodities?

During the 1980s and 1990s, the average investor would have held a zero weight toward commodities. Today, an appropriate weight would be much higher, closer to 40 per cent or more. Of course, your age, risk tolerance and level of investment sophistication will figure prominently in this decision and may cause this weighting to fall.

What’s the cheapest way to get exposure to commodities?

The cheapest way is through exchange-traded funds that are backed by physical commodities. That way, investors get low fees, and the price tracks the price in the here and now as investors would expect.

What sort of allocation do you recommend between the various commodity classes?

Of your total portfolio, including the non-commodities portion, gold should represent 10 to 15 per cent. Of the commodities portion, energy should be 30 to 35 per cent, base metals 25 per cent, agricultural should be 25 per cent and bulk commodities, such as coal and iron ore, around 20 per cent.

So you think gold still has room to run. What about all those poor folks who bought gold back in 1980 at $850 (U.S.) an ounce, only to watch the price collapse?

The U.S. has in the past used the printing press to flood the money supply with more dollars and, in essence, debase the dollar. They did it after the Second World War and they did it after the Vietnam War, and those were both times that gold started to soar. That’s why with QE2 [a second round of quantitative easing] being floated there’s a lot of concern that’s what the U.S. intends to do – inflate away their problems. You want to hold gold if that scenario unfolds. If there’s any time to buy gold, it would be now.

What’s in your personal portfolio?

All of the things I say. I have about a 15 per cent weighting in gold, mainly gold producers but I also have the SPDR Gold ETF [GLD-N], which is probably the most common. And I have well over half my portfolio in commodity-oriented stocks. I also have some dividend stocks, too, a few bond funds and some cash for buying opportunities down the road.