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Oil is a drag on the global economy but an opportunity for investors

Oil is a drag on the global economy but an opportunity for investors

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In the revolving door of global economic worries, the price of oil has now taken the spotlight as concern number one given the waning anxiety over Europe’s sovereign debt crisis and the prospects for continued improvement in economic recovery in the United States.

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Crude oil has certainly proved that if anything, it is highly volatile.

From an all-time high of US$145 a barrel in July 2008, the price plummeted to $30.28 in December 2008 and is now trading at $107 a barrel.

The impact of higher oil prices has historically severely damaged the global economy, especially in times of geopolitical tensions such as the Arab oil embargo and Iranian revolution in the 1970s.

This has created a disruption in supply, whereas the rapid price ascent over the last 20 years has been largely a result of increased demand and price speculation. 

The old rule of thumb that a sustained 10 per cent rise in the price of oil shaves around 0.2 per cent off global growth in the first year may be challenged.

The origins of higher prices matter most.  

A strong global economy will cause a rise in demand and an increase in prices. If the economy weakens, demand should drop, and prices decrease.

With a supply shock, prices rise and therefore demand declines.

However, prices will remain high given the lack of supply, and as a result will do more damage to global growth than higher prices that result from demand.

The very people making the most noise on the potential damage of higher oil prices, governments and Wall Street, seem to be the people most responsible for it.

Central banks have kept interest rates at extremely low levels and injected liquidity in the markets in an effort to spur economic growth.

With real interest rates negative in most developed economies, there is no reason to keep money in the banks or bond markets, thus the shift to more risky assets such as equities and commodities.

Speculation on oil futures by investment banks, hedge funds and commodity traders has contributed to both volatility and higher prices.  

The real danger is a political crisis, especially if it involves a major oil producing nation.

That risk remains a possibility with escalating sanctions on Iran, who stubbornly remains committed to developing it nuclear capabilities, and the possibility of military action by either the Israel or the United States. 

The Arab Spring last year resulted in price spikes and extreme volatility, further uprisings are highly likely in the region.

While higher oil prices are not pleasant for most us, it does present an opportunity for investors.

Whether investing directly in oil-related stocks, mutual funds, exchange-traded funds or derivatives, there are many ways to invest in the upside and downside of the price oil.

Most market analysts rate the energy sector as the best area to invest in 2012.

If there is a flare-up in the Middle East, oil-related assets can be a natural hedge as they will likely rise in price with most.

Anthony Galliano is the chief executive of Cambodian Investment Management 
[email protected]

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