Cheap Oil, The Economy and Your Investments

Lower prices for oil and gas have given the typical American something to smile about in recent months. But experts are still debating whether cheap oil will be good for the economy and investors in the long run.

Here’s the background. Oil prices have dropped by as much as 60% in the past seven months amid a glut of supply and falling demand. After topping out at $115 per barrel in June, the price of a barrel of oil dropped to $45 early this year. Prices have rebounding in recent days but are expected to hover below $60 for the remainer of the year.

Consumers are loving the savings, of course. And many economists are enthusiastic as well: Falling oil prices have historically bolstered the economy, as consumers use the savings to buy extra goods and services.

However, consumers don’t appear to be following the script this time around. Based on disappointing spending data, some economists have concluded that Americans are simply using their fuel savings to pay off debt.

Has cheap oil has benefitted investors? The answer depends. Oil’s fall has helped to stoke stock-market volatility, but investors with well-diversified portfolios have largely escaped the damage.

Those who have made outsized bets on oil, on the other hand, have taken it on the chin. In the past five years, more than $1.4 trillion in investments have flowed into the industry, according to Bloomberg. The drop in oil prices has wiped out a total of $393 billion in value since June. This damage should serve as a stark reminder that taking disproportionately large positions in any one industry is risky business.

Falling prices have hurt the oil industry, of course, but they’ve also impacted countries that rely heavily on oil revenue, such as Russia and Venezuela. The result has contributed to lagging performance in emerging markets. Furthermore, some observers feel that a lengthy period of low oil prices could spark geopolitical conflict.

Cheap oil does have a potential upside for investors. As oil stocks have declined, stocks and bonds of the strongest companies have begun to look more attractive based on their valuations. Furthermore, companies that pay less for energy may be more profitable, helping to boost their stock prices.

How long will oil stay cheap? No one knows for sure, of course. If prices remain depressed for too long, oil producers could cut back on production significantly. And the decreased supply could mean much higher prices once demand picks up.

In short, it’s difficult to predict just how the cheap-oil story will play out in the coming months and years. Luckily, prudent investing doesn’t require us to answer that question. With properly diversified portfolios, patience and discipline, investors should continue to enjoy participation in the market’s gains and protection against its risks.

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