During the first week of January (2015), the price of oil went below $50 a barrel and I filled up my gas tank in my SUV for less than $30! As a result, several people asked me if it is time to invest in oil. There is currently a lot of talk about declining oil prices and the effects on the economy – but I want to discuss oil as an investment.
First of all, I am almost never asked about adding stuff to portfolios that have gone down. So in this respect, this is a very good question! Instead, investors normally ask me about adding market areas after they have done well.
Now to my answer. Is now a good time to invest in oil? NO. There are four main reasons why oil and commodities in general don’t belong in your portfolio.
The first reason is that, from an academic perspective, commodities (oil, gold, silver, copper, timber, etc.) are not an investment. An investment, by definition, has to produce something. The price of commodities is based solely on supply and demand. In the case of oil, supply is currently relatively high and demand is relatively low, so the price of oil has fallen, as you would expect. In a 2008 USA Today article titled, “Read This Before You Jump on the Commodities Bandwagon,” Mark Krantz wrote, “Remember when you buy a commodity, you’re not buying something that generates earnings and profit. You’re buying a hard asset and hoping another buyer will be willing to pay more for that asset in the future.”
The second reason why you don’t need to add oil (and other commodities) to your portfolio is logistics. Unless you are going to take physical possession of the hard asset (in this case barrels of oil) on your property or in a storage facility, you have to buy exposure to the commodity via derivative markets (such as the futures or options markets) or buy mutual funds or ETFs that buy these derivatives. These are highly speculative and extremely volatile investments. Furthermore, the returns of these derivatives can often vary greatly from those of the underlying hard asset.
The third reason has to do with returns, which simply are not very good. In this case, the long-term rate of return of oil (from 5/83 to 10/14) was roughly the rate of return of inflation.
The fourth reason for not investing in commodities and oil is that, despite what some say, they are not a good hedge against inflation. A noted economist and professor of finance at Dartmouth, Kenneth French, has done extensive research on this and finds that commodities are not a good inflation hedge. He was interviewed in 2008 by Business Insider and describes in a short video clip how inflation is a relatively static metric that tends to vary just slightly over time. The idea of adding a volatile commodity asset (such as oil) to temper a metric that varies slightly, such as inflation doesn’t make sense. (Note: the video clip is no longer active on this site but I can email it to you if you want to see it. Watching it is two minutes well spent).
So the long answer to the question of should you invest in oil or commodities now is NO. Rest assured that your diversified portfolio already has exposure to companies that are tied to oil and energy so do nothing other than enjoy filling your tank for less while it lasts!
 Matt Krantz, “Read this before you jump on the commodities bandwagon,” USA Today (McLean, VA), Jun. 24, 2008.
 Blodget, Henry. “No, You Shouldn’t Own Commodities — Ken French.” Business Insider. Nov. 18, 2008. http://www.businessinsider.com/2008/11/no-you-shouldn-t-own-commodities-ken-french