We are on the verge of another financial crisis even bigger than the real estate collapse.
This time, it's in oil. It's not a supply/demand problem, or a geopolitical one. Rather, the crisis stems from the rising inability to determine crude oil's genuine value.
A new round of speculation is growing, manipulating the energy markets. When no one can figure out how much oil should really cost, prices rise artificially… leading to catastrophic fallout.
Oil sector investments will be just a fraction of the global consequences. Oil touches everything. Even if you don't invest at all, this crisis will almost certainly affect you.
Oil Is No Longer About A Wet Barrel Of Crude
Today's oil market is one fueled by instability, intense volatility in pricing and trading, and a level of uncertainty not seen since the late 1970s.
The thing is, the price of oil and oil products has very little to do anymore with oil as a commodity. Instead, oil futures contracts have become an asset themselves – and a structurally flawed one.
I strongly believe this problem could very well be worse than the mortgage crisis, and I believe that it won't be solely confined to just oil. Toxic paper in the oil industry is going to touch everything. It doesn't matter if it's directly tied to oil or not.
This is an investing issue, a price issue, a national security issue, a political issue, and a personal issue.
Volatility is the new lightning rod for the entire energy sector. And as it intensifies in the oil market, determining genuine asset value becomes more difficult. While oil prices will be increasing, the rise will not result in corresponding increases in the genuine value of underlying assets.
This problem has occupied much of my time over the past several years, and the reason is simple – if left unchecked, this gap will result in a global financial bubble far worse than the subprime mortgage meltdown.
But there are ways to protect your wealth. Click here to learn more about one oil industry investment that could turn the coming crisis into a profit opportunity.
Derivatives Drive A New Crisis
The major players straddling the paper barrels (futures contracts) and wet barrels (consignments of actual oil) are designing new, ever more complex, synthetic debt and swap instruments to make the increasingly square pegs of futures fit into the round holes of oil deliveries.
Simply put, the market price for oil futures does not reflect the actual value of the oil itself. What it reflects is the value put on derivatives by traders who need a profit spread on that paper to stay in business.
Sound familiar? This is exactly how the financial crisis started.
With oil, however, the impact will be far more pervasive.
Oil is now a financial asset, not simply a commodity. That means trade in its future prospects attracts a lot of speculative attention bearing little relation to the oil itself.
Much like one can bet on the total number of points scored in a football game (the "over-under") without caring who wins, so we are witnessing growing interest in maximizing the price spread of futures over "real oil."
Both are derivatives – one on a sporting event, the other on a commodity. Neither should be considered reality as such.
Unfortunately, that is what has happened with oil. Investors with little interest in oil deliveries are pouring into oil futures. And they're producing new derivatives to squeeze speculative value out of yet other derivatives. That progressively undermines the market value of the oil itself…
No One Will Escape The Fallout
As these derivatives build on one another, what we are likely to experience is a bigger credit crunch fueled by the inability to value a fundamental asset, oil. Few, if any, international markets will remain unscathed.
This volatility will inflate a new oil bubble – one that will make the all-time highs of 2008 look like child's play. Plan to see $200 oil prices, and even higher, in the near future.
The new reality in the oil markets will revise the playing field of world politics too. Legislative and regulatory decisions impeding free trade… cross-border capital flows… and access to assets.
There is no deliverance from oil volatility. There is nothing government can do to prevent it and much of what it will try is unfortunately only likely to make matters worse.
Luckily, there are a few steps the average person can take to protect himself. Specific things to look for in the months ahead – what to avoid and a few key steps investors can take to profit from oil volatility…
How To Be Prepared
Supply and demand no longer control the oil market. And pundits are grasping at straws to explain the irrational moves we're seeing everyday in oil prices.
Just like the real estate and financial crisis of 2007, the coming oil crisis will have nothing to do with the underlying investments at stake – and everything to do with the inventions layered on top of those investments.
The flood of money into the derivatives oil market – and the creation of new "derivatives on derivatives" – will drive oil prices higher. But getting there is going to be a bumpy ride, with traders on both sides looking to capitalize on the volatility they've created.
As an outside investor, you should be doing the same. Volatility is the major factor driving oil prices in coming months and years. And investors who recognize this will be in the best position to survive and thrive when the bubble bursts.
Look for stocks, ETFs and indexes that play on the volatility of the oil markets. To find specific recommendations, click here for our latest special report.