Oil: Buy Now or Steer Clear?

It's a simple question: Has the price or oil bottomed out and presented a buying opportunity, or should investors steer clear? Of course, that's impossible to answer definitively. Too many unpredictable factors could intervene. We'll have to ignore those for now and focus on supply and demand.

China

China is the second-largest economy and the biggest energy consumer in the world. Chinese stocks just dropped 6.1%. The Chinese government has done everything in its power to keep stocks propped up by using several creative tactics, including banning short selling, halting initial public offerings (IPOs), using media to encourage already over leveraged investors to buy stocks and more. (For more, see: What China Devaluing its Currency Means to Investors.)

The Chinese government’s most recent move was to devalue its currency, which would increase exports. But the Chinese government will only be able to prop up equities temporarily. The 6.1% plunge in equities is an example. But the Chinese government won’t give up. What happens next? In all likelihood, the Chinese government will continue to devalue its currency. When that happens, it will lead to the reduction of consumption. Remember, China is the largest consumer of energy in the world. This won’t bode well for the price of oil.

Japan Provides a Hint

Commodities are coming down across the board, which also acts like a heavy weight on the price of oil, dragging it down because investors begin to see that there is no consumer growth anywhere. Look at Japan, for example, where the economy contracted 1.6% in the April-June period. (For more, see: Top 5 Japan ETFs.)

Japan might not be the biggest factor in the world these days, but it’s sending a strong message if you look at the big picture. Japan has been fighting against deflation for decades. In recent years, Abenomics – increasing the nation’s money supply, boosting government spending and enacting reforms to make the economy more competitive – was expected to lift wages and increase consumer spending. But it’s failing. It wasn’t long ago when it appeared to many that Abenomics was effective and that it was possible for economic problems to be solved with spending. Fortunately, as more signs of failure become evident in countries throughout the world, this concept will prove to be futile, if not very damaging.

What’s taking place in Japan is foreshadowing what will take place in China, the Eurozone and the United States. Spending your way out of a problem doesn’t work. If you lost your job and needed to use your credit card to purchase goods and services would the end result be better or worse? (For more, see: What Could Happen If the Eurozone Breaks Up?)

Other Key Factors

Domestically, the impact of the Federal Reserve's accommodative monetary policies has lessened considerably, thereby no longer driving artificial inflation. You might be thinking that low oil prices are good for the consumer, but the consumer will only spend if they believe they will have more money in the future. How many people do you talk to these days feel confident they will have more money in the future? Then you have sliding transports and industrials as well as a strong U.S. dollar, none of which are good signs for the price of oil. (For more, see: Best Places to Go on a Strong Dollar in 2015.)

The Bottom Line

There is no upside catalyst for oil right now and this is likely to remain the case for several years. If you are thinking of going long on oil, first ask yourself: Where will demand come from? We didn’t even get to oversupply, which is another bearish factor. In my opinion, it would be wise to steer clear of oil.

(For more, see: Invest in These 5 Industries When Oil is Cheap.)