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Oil's new bubble

Created:

25 June 2009

Written by:

Daniel O'Sullivan

Crude oil prices have doubled since the start of the year, despite a slowdown in demand and plenty of spare capacity in the Opec producer nations. We think that speculation is what's driving this appreciation, and that investors are better off on the sidelines for now. If oil prices were to continue to rise, we'd advise those with strong risk appetites to consider going short.

Oil's spectacular recovery has got the bulls lowing all over again. Wall Street titan Goldman Sachs, the üeberbull of oil price forecasting through last year's bubble, recently upped its end-2009 oil price forecast from $65 per barrel to $85 and instituted an end-2010 target price of $95. The apparent early recovery of emerging Asian markets, in particular China's commodity import frenzy over recent months, is seen as vindicating the 'commodity supercycle' theories – demand is insatiable, and supply cannot react quickly enough.

We disagree. Demand growth is anaemic, supply is more than adequate, and $70 oil is more a function of speculation than economics. We've identified five rules to help investors gauge what's happening in the oil market and avoid making decisions that could end up being costly – such as buying shares in companies that are already richly valued, or becoming dependent on takeover activity to generate further share price gains.

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