Instability as Investing Tool

I’ve written previously about how to use demand and the tracks of hedge funds as investing tools, but now we have another one: instability.

Instability can take the form of political, environmental, archaeological, and countless other forms. The one we’re interested in today is political.

As you’ve seen on the news, Nigeria is up to their old tricks again, and apparently it’s enough to send certain American-based oil companies out of the region to let things play out. While those pumps are unmanned, supply is trapped in the ground, making the oil we have now worth more. The price has gone up about $3.00/barrel or so in the last few days, and all I had to do was sit and watch.

OPEC can’t regulate their way out of this one, and Russian oil is pretty much cornered by China thanks to several private deals. The world still needs oil to make it go around, and it will come at a higher price in the short term. Looking at last year’s returns, all these “short term spikes” added up to a nice 44% gain for 2005 using the Vanguard Energy Index fund.

While I’m fairly confident Vanguard didn’t put all its fund eggs into one greasy basket, it did manage to make decent YTD returns on the short term spikes of gasoline and natural gas as well as oil.

Many years ago, something similar was happening in the diamond market—Rwanda and other African countries were (and still are) fighting it out over ownership of the diamond mines. Back then, diamonds were thought to be a precious commodity, limited in formation and location. DeBeers cornering the wholesale market didn't help either. Diamonds were expensive because they were thought to be exclusive, but no more. Now, we have lab-grown diamonds, diamond deposits in northern Canada, and cubic zirconium to take their place, yet Rwanda and other regions of Africa still fight on over what now amounts to very pretty industrial glass. Nobody wants "blood diamonds" any more.

When something effective comes along at an affordable price to take the place of oil, it too will fade in popularity and demand. I imagine the oil-producing countries will still be duking it out over political superiority, and it will be for naught. This probably won’t happen in my lifetime, though.

In the meantime, all we can do is watch the horizon and learn to use instabilities to our advantage. We pretty much know by now where the “hot spots” are, what they have to be hot over, and how to invest in them. Some people think it’s a shame to be profiting from the misfortune of others, especially when it happens in Third World countries, but I say that we can’t help them if there’s no reason to get involved in the first place. They have something we want, and we have something they want—an even exchange of oil for money at prevailing market prices sounds fair to me. Nobody’s getting hurt here, except maybe the citizens on the ground—that is beyond our control.