Who would predict the price of oil?

Posted on 06/12/2014. Filed under: A step by step approach to producing a financial plan, academic approach to investing, Active v Passive, Altrincham, arithmetic of active management, asset allocation, cfp. chartered financial planner, Cheshire, chris wicks, chris wicks cfp, ChrisWicksCFP, Dimensional, Efficient Markets, Evidence Based Investment, Factors of investment, financial planning, hidden costs of investment, Increased ISA Allowances, Index Investing, ineffectiveness of active fund management, investment, lack of predictability, Lessons from past financial crises, Market timing, passive investment, Professor Kenneth French, PTR, Retirement Options, retirement planning, Sources of financial advice, William F Sharpe | Tags: , , , , , , , , , , , , , , , |

The price of crude oil has fallen around 40 per cent since a recent peak in June this year. This has a profound effect on economies and markets around the world as the cost of manufacturing and transporting goods falls along with oil producers’ income and the currencies of oil-rich countries.
The theory goes that consumer spending will rise because people have more disposable income; that inflation will fall as the price of goods eases; and that companies with high energy bills will become more profitable. If lower prices hold, the effect might become political and environmental as the balance of world power shifts from oil exporters to oil importers, and the impetus to develop cheaper clean energy wanes. Oil seeps so deep into the global economy you might think that to be a successful investor you need to have an accurate view on its price and its impact on asset prices. But you would be wrong.

No-one with an opinion about oil knows whether their view is right or wrong, and only the changing price will confirm which they are. Market prices are a fair reflection of the balance of opinion because they are created by many buyers and sellers agreeing on individual transactions. As an investor you can take a view of whether that balance – that price – is right but, like all other people with an opinion, you have no way of knowing whether you are right or wrong until the price moves.

Knowing this, it seems irrational to take a view (or a risk) on something so random as the direction of the oil price. In fact, why would one take a view on anything related to the changing price of oil; the US economy, for example; or the price of Shell; or Deutsche Post; or anything else?
The rational approach is to let capital markets run their course and to have a sufficiently diversified portfolio that allows you to relax in the knowledge that, over time, you will benefit from the wealth-generating power of your investments as a whole; without risking your wealth on a prediction that might go one way or the other.

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