The oil 'juniors' set to strike gold

The price of gold has again been making headlines and breaking records. I remain a fan of gold given the debasement of paper currencies via quantitative easing. Yet another commodity has been gaining ground, and its increase has far more important ramifications for the global economy: oil.

You might have expected the price of oil to have fallen back given that Western economies are hardly firing on all cylinders. Instead we are at around $90 a barrel after seeing lows of around $35 only two years ago. It goes to show how much the world has changed over the last 10 to 15 years. Previously a recession would have seen the oil price falling back, but now there is additional demand from emerging markets it is no longer the case. Emerging economies are on a roll despite the woes in the West and with 87 per cent of the global population and 52 per cent of world GDP it is they who are now the major players.



Some commentators argue emerging economies are in danger of overheating, which I agree is a risk, but in the long run it all seems part of a 'super cycle', the likes of which have been seen before. The previous occasions were the late 1800s and early 1900s, stimulated by the industrialisation of the US, and then the post Second World War period driven by the reconstruction of Europe and Japanese expansion. This time around it is the nations of China, India and Brazil rapidly industrialising, increasing demand for oil and other commodities. More people, cars, buildings and infrastructure means greater demand on the world's finite supply of black gold – and that means higher prices.



Of course it is impossible to forecast where the oil price may be going in the short term. Weakness may well result from problems in emerging markets, particularly China which could face a slowdown in growth. Yet the long term prospects for oil must be good unless we can widely adopt a new source of energy and build the necessary infrastructure around it – something that seems unlikely, at least in the near term.



So filling my car with petrol recently has been a depressing exercise with pump prices seemingly going up every other day, but one thing has helped me feel better about it: my investment in Junior Oils Fund. It is run by Angelos Damaskos, a man with 19 years' experience in natural resource investments, and, as its name suggests, it invests in smaller oil companies as opposed to the large oil majors that most people are familiar with such as BP and Shell.



I say smaller, but in some cases they grow to become quite large. For example, a previous holding in the portfolio, Tullow Oil, is now a FTSE 100 company. The fund is certainly specialist, but Mr Damaskos tends to buy profitable companies with plentiful reserves. These companies frequently make takeover targets by larger firms looking to boost their production, and since the fund was launched there have been 15 takeovers of portfolio holdings, including Dana Petroleum, which was recently bought by the Korean state oil company.



In his analysis Mr Damaskos looks carefully at a company's oil reserves and examines the cost of extraction. He clearly wants good management too, and while he likes some exposure to exploration activity he wants to ensure that the discovery of a dry well doesn't sink the company. A typical initial weighting to a pure exploration firm is around about 0.5 per cent, so a problem holding won't sink the fund. Yet the rewards of buying some of these firms can be huge. For instance, Caza Oil and Gas has rocketed from the bottom of the list to the top holding at 9 per cent through share price performance alone.



So while there will be periods of weakness in the oil price, these types of companies should remain sought after for as long as oil retains its dominance in the world economy. It is a frightening prospect that the oil price could exceed $200 a barrel in the next few years if the world cannot find a better alternative. So I would suggest any price weakness in this fund should be viewed as a buying opportunity.



Mark Dampier is head of research at Hargreaves Lansdown, the asset manager, financial adviser and stockbroker. For more details about the funds included in this column, visit www.h-l.co.uk/independent

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