Why the Commodity Bull Looks Likely to Charge

Whoosh!

There’s no other way to describe the move in oil since last week.

The US contract for August delivery rose 4.6%. It’s the biggest one-day gain since 2016.

We can thank the Organization of the Petroleum Exporting Countries (OPEC) for that.

The announced rise in oil production is less than the market was pricing in.

Now we need to see if oil can hold on to the gains.

In the short term, I can’t really tell you what’s likely to happen. But looking out 18 months from here, I’d be staggered if oil is lower than it is now.

That’s why I’m watching oil stocks very closely.

But this is also important because of the impact it will have on the Aussie market.

BHP Billiton Ltd [ASX:BHP], for example, gets about 18% of its earnings from its petroleum division. Which means that BHP should help lift the ASX today.

After all, each $US1 rise in the oil price can add $US64 million to BHP’s revenue.

And don’t forget natural gas. A 10 cent rise in the US natural gas price adds US$23 million to BHP’s bottom line.

History to repeat

I mentioned in last week’s Daily Reckoning the chat I recently had with investing legend Jim Rogers. In preparation for our talk, I went back and read the oil section of his 2004 book, Hot Commodities.

The similarities to what Jim was saying about oil then to how things are shaping up for oil now are quite striking actually.

Oil was around US$40 a barrel in 2004. It had risen from US$10 six years earlier.

There was grumbling from bureaucrats, politicians and consumers about high prices. In fact, the US government and OPEC kept wrangling over the different price they’d preferred to see oil trading at.

Yet there was one problem: Both the US government and OPEC were living in a fantasy land where they assumed they could control the market.

That became obvious when oil hit US$147 four years later. The prior underinvestment meant there simply wasn’t enough oil that could get to market.

I think there’s every chance of oil running up in a similar way in the near future.

It won’t be a straight line, of course, and oil could even go down for a bit. But the structural tightness in the market is leaving the world with low inventory and low spare capacity.

If any wildcard comes along and knocks out production further, oil could spike in a big way.

I’m starting to see quite a bit of research come through about the opportunity in commodities in general. That’s because they’re cheap relative to stock and bond prices around the world. Fund managers looking for growth and less downside risk are going to see value here.

In fact, even my US colleagues are tipping Aussie miners at the moment.

It’s not hard to see why.

In general, not a lot of new supply has been invested in over the last few years, and demand looks solid.

Even the price of US natural gas has been creeping up lately too. It’s up about 16% since February — and there’s been huge investment and supply of natural gas over the last five years. That suggests there’s strong demand out there.

Certainly, this should pour more free cash flow through BHP’s accounts, all else being equal. It should also give the company a strong bargaining position for the sale of its shale assets in the US.

The more price strength that BHP exhibits, the stronger the ASX will look. This could draw in more buyers as regular reports about the stock market hitting new highs keep filtering out.

We’ll have to wait and see on that. But remember: Investors never chase bear markets; they’re drawn to rising markets.

Perhaps an open question is whether mining companies have done enough to win back investor trust. That’s on the mind of Jake Klein right now, the chief executive of gold stock Evolution Mining Ltd [ASX:EVN].

Klein says the gold industry in general needs to win back both the retail investor and investment manager. He says the scar tissues from the boom and bust years is still there despite Aussie gold stocks being low-cost and some showing great share price performance in recent years.

I happen to think mum and dad investors will come back, but it will take a surge in commodity prices to make it happen. There’s nothing like the prospect of a huge and unexpected windfall in revenue pouring in to get the blood going. Commodities can make that happen in a way few other sectors can — and fast.

All told, the move in oil I described above could just be a small taste of what’s to come. Stay tuned.