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Relationship of oil, stocks leads to ugly truths

First mentioned here in 1980, the Barrel Standard is a measure of wealth I introduced to track the exchange rate between the price of oil and the stock market. Then, as now, oil prices were establishing new highs and stock prices were sinking.

In 1970, oil was $3.18 a barrel. Think of it as the good old days. It was three years before the OPEC embargo reminded us that we need oil from the Middle East to run our economy. The Standard & Poor's 500 index was at 92.15. That means it would take the equivalent of 34.5 times the S&P 500, which we'll call units, to buy 1,000 barrels of oil.

By 1975, oil prices had more than doubled, and stock prices had fallen. So it took 85 units of S&P 500 to buy 1,000 barrels of oil. And by 1980, when investors were about to give up on stocks, oil was $21 a barrel, while the S&P was 135.76. So it took 159 units of S&P 500 to buy 1,000 barrels of oil. That, it turns out, was near the peak for oil and the bottom for stocks.

By December 1998, the last time I wrote about the Barrel Standard, oil was down to $11.18 a barrel and the S&P 500 was up to 1,149. As a consequence, you needed only 9.7 units of S&P 500 to buy 1,000 barrels of oil.

Oil was dirt-cheap. We had enjoyed nearly two decades in which you needed less and less stock to buy a barrel of oil. Viewed as an exchange rate, oil had fallen by 94 percent.

Today, with oil near $40 a barrel and the S&P 500 index lower than it was in 1998, the trend has clearly reversed. It now takes 38.7 units of S&P 500 to buy 1,000 barrels of oil.

One message is very clear: When oil prices rise, stock prices tend to fall. When oil prices sink, stock prices tend to rise.

The question is whether $40 a barrel oil is or isn't a transitory peak. My view is that it's the new reality. The era of cheap oil is over. As outlined in The Coming Generational Storm (MIT Press, $28), my money is where my mouth is: I've invested in energy stocks as a substitute for dollar-based investments. Here's why:

Ugly Reality No. 1. We love unlimited energy, but we don't want to do anything to get it. Our capacity to deliver and refine oil is inadequate. We either have not invested enough or have not been allowed to invest enough. The most visible current example is Massachusetts. They don't want wind farms off Cape Cod. They don't want increased liquefied natural gas capacity, either. But they still expect heat and light.

Ugly Reality No. 2. The Middle East remains the largest pool of oil reserves in the world. That's bad news. There are promising areas for exploration elsewhere, but it is unlikely that any new find will rival the fields in Saudi Arabia. Meanwhile, global demand continues to increase. The supply-demand balance is likely to be a source of instability for the foreseeable future.

Ugly Reality No. 3. There are disturbing signs that Hubbert's Peak is arriving as predicted. Using the techniques of geologist M. King Hubbert, who predicted in the 1950s that domestic oil production would peak in 1970, others have predicted global production would peak in this decade. Today, with production declines in some important oil fields, the idea is attracting more attention.

Questions about personal finance and investments may be sent to Scott Burns, P.O. Box 655237, Dallas 75265; e-mail can be sent to Burns' Web page is

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