INVESTING: Betting on oil still wise, but temper expectations

It finally happened. The big event has come and gone, leaving a trail of clues for us. Now, it’s up to us to take those clues and turn them into cash.

It’s not the recent lunar eclipse I am referring to, although I watched it and it was cool. I am talking about oil finally closing at more than $100 a barrel. One trade at the end of 2007 took oil above $100, but it didn’t close there.

Oil fell as this year began, but it’s been on a progression up since the end of January, when the Fed slashed interest rates. It finally closed above $100 on Feb. 19. An old Wall Street belief is that prices eventually get drawn to big, round numbers. As oil was selling for around $10 a barrel in 1999, $100 was a big, round number.

It goes without saying that success on Wall Street requires a little independent thinking. With oil hovering around $100 a barrel, most people are still talking about how to profit from the upside. While I still believe oil can reach $150 by the end of 2010, we might see some rocky action for several months. Those clues I mentioned before? Let’s get to them.

From the middle of 2002 until October 2007, Exxon was a terrific stock to own. The entire energy sector was lights out for five years. As you might expect, that closely correlated with the relentless rise in oil prices. But something is different this time. Oil has reached a new all-time high, but the energy sector is still 5 percent to 10 percent below highs set last October.

Four months of a divergence is long enough to cause concern. I keep a series of indicators that serve as reliable predictors of what may happen to price. Since October 2007, oil has set a series of slightly higher highs, but the indicators have a pattern of slightly lower highs over the same time frame. This is not good for oil bulls.

Emerging-market demand has played a huge role in pushing oil prices higher, but the falling U.S. dollar deserves its share of the blame. Oil is priced in U.S. dollars on the global market, and if the dollar falls, oil producers simply want more dollars so they come out even.

Evidence is growing that the U.S. dollar is in the early stages of a rally that could help dampen the run-up in oil prices. Long term, the euro is vastly overvalued against the U.S. dollar, and the euro is the currency that has gained the most attention as the dollar has fallen. I believe the dollar can rally against most currencies for a few months at least, and against the euro for maybe several years. That’s another reason oil could pull back short term.

Still, there’s longer-term potential in energy, especially if prices fall 20 percent. Unlike financial stocks (which, contrary to everything you are hearing, are not showing any interesting accumulation that could lead to a sustainable move higher), energy still has an upside. The ride is going to be more volatile and the returns lower than the last few years, however. So, if you see yourself paying $2.50 a gallon anytime soon, open your portfolio when you get home and look at some energy plays.