Warning: Falling Oil Prices is a Bad Thing

warning-stockphoto“I don’t get it,” my mother-in-law said over the New Year’s break. “Shouldn’t lower oil prices be a good thing?”

“Gas prices are cheaper, so that should help people and businesses in their transportation cost. And practically every product out there has some type of petroleum product in it, like plastic.

“So if the cost to get a product on the store shelf just dropped by $5 because of the fall in oil prices, then why isn’t the fall in oil prices a good thing? Isn’t that an additional $5 profit that goes directly in the company’s pocket?

[ad#Google Adsense 336×280-IA]”Also, why is the falling oil price causing stock prices to fall?”

Whew – and I thought I was off the clock on the New Year’s break…

First off, falling oil prices by themselves are not causing falling stock prices.

In short, falling oil prices are a big red flag – falling oil prices simply tell us that the world economy is REALLY NOT HEALTHY right now.

This red flag causes investors to get concerned, and they sell stocks.

Today, the world’s stock markets are struggling because of changing expectations – investors have now realized that the world economy is not as well off as people thought six months ago.

Looking directly at oil… The world oil price is based on supply and demand:

  • Oil prices soar when global oil demand soars and the oil supply stays roughly the same. And…
  • Oil prices soar when the supply shrinks and the demand stays the same.

Right now, we’re in the extreme situation where supply has soared thanks to new technologies (which causes a falling oil price), AND global demand has shrunk due to a weak global economy (which also causes a falling oil price).

It is a unique and extreme situation.

The increase in supply is good… It allows that company to have that additional $5 profit on the item sitting on the shelf. However…

The decrease in global demand is bad… It means that the item on the shelf isn’t selling. So there is no profit at all from it. Until it sells, companies make less money.

In summary, the falling oil price by itself is not causing global stock prices to fall… The falling oil price is just a strong red flag that the world economy is weak.

That’s a simplified picture of how it works. But it’s pretty close to reality right now.

What do I think?

I think we could make a lot of money in oil-company stocks – someday. But not yet…

As I explained earlier this week, it’s not time to buy oil stocks yet.

As a contrarian investor, I also say this is a good time to buy U.S. stocks in general… as investors are currently scared.

If investor perception simply moves from “bad” to “less bad” in the global economy, stocks could shoot much higher.

Even though the price of oil is down, and the global economy is weak, I am not a seller of stocks…

Good investing,

Steve

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Source: Daily Wealth