This is, in large part, due to the geopolitical premium that has built up in the commodity on fears of supply disruption from a potential strike on Iran from Israel. Other commodities have been roughly flat, with the notable exception of Natural Gas crashing through the floor:

Until we start seeing more consolidation and shutdowns of natural gas drillers and producers, this supply-demand picture is not going to be changing anytime soon. Big fish such as Encana (TSX: ECA) look cheap, but until we start seeing liquidations of smaller players or spontaneous construction of significant amounts of natural gas burning facilities, I would not be touching natural gas commodities. Notably in the peak of the last economic crisis, natural gas went down to US$2.5/mmBtu and at that level it would bankrupt most leveraged small producers. Larger companies like Encana just need to wait with a pile of cash and mop up when the time is right.

As for the oil markets, it will remain volatile as traders are seemingly using it as a proxy for geopolitical event risk.

Commodity markets have always been prone to huge booms and busts, and this one is not going to be too different – whether the “bust” will be the existing 15% correction we have seen, or whether it will be something more deep remains to be seen. The more people that had or have conviction that the present correction is simply an aberration on a longer trend, the more likely it is that the markets will continue to take these people into loss positions. The market might not be tasting blood quite yet, but a whiff of it is in the air.

My portfolio positioning continues to be extremely defensive and with little linkage with the performance of oil and gold. This exposure might increase if the market is tasting blood, but this is not going to happen until I start seeing different psychology than what is out there today with commodities.

The lowest risk commodity appears to be natural gas, simply by the virtue of not having had a run-up like the others.

It seems like when Osama Bin Laden got shot, that it also took out the wind of the commodity market. High-risers, especially silver, got pummeled this week:

Who wants to be the person admitting that they bought Silver at $50 an ounce?

Anecdotally, I was walking down the street a week ago and remember these two people walking out of a currency exchange store, and they were clearly holding silver coins as they exited the place. Maybe I should have taken this as some sort of contrarian signal and short the commodity, but I was too busy with other matters to do so.

Also, it is my opinion that the indexes appear like they will be treading water and not exhibiting the run-up that they were doing between September 2010 and February 2011.

My trading gut instinct says that the crude market may be a tad overextended at the moment, presumably due to geopolitical instability.

Modern historians should note that Iran and Iraq went through a decade-long war, yet the Persian Gulf still managed to export billions of dollars of crude.

The big shoe to drop is the answer to the question of “What happens in Saudi Arabia?” since they control a significant source of supply globally. That said, it is highly likely that the oil will still flow since whoever is left to control government will still want the cash cow – what will be significantly more disruptive is that the incumbent administration knows it will be kicked out, but has plenty of notice of its pending demise. In this scenario, they will likely use the “scorched earth” option, similar to what Saddam Hussein did in Kuwait prior to the first Iraq invasion.

Readers will likely note that their holdings in Canadian oil sands related companies have received a significant amount of appreciation over the past 6 months – partly related due to the market conditions and improving economy. Here is a chart of Cenovus (TSX: CVE), but you can pretty much fill this in with the usual suspects (Suncor, Canadian Natural, etc.):

The last spike up over the past month is a function of higher crude prices and geopolitical instability – I’d estimate of the $6 that it has gone up from $32 to $38, half of that is due to crude, and half of it is implied instability.

That said, it seems like an easy trade to pile in at the moment, so be very cautious – when others think alike, your risk/reward ratio becomes more adverse.

It is clear that logistical issues with exporting Canadian oil sands crude will continue, especially if the Enbridge pipeline from Alberta to the Pacific Coast does not proceed. Oil sands production is steadily increasing so the supply pressure will continue to be apparent.

Although crude oil is being mined out, it is subject to cyclical patterns of supply-demand cycles. It should be noted that the last crude spike (in the middle of 2008) was so excessive that in conjunction with the economic crisis, pushed crude down 75% at its trough – producers still must produce supply but if demand lessens they must receive a lower price for the product.

In terms of cost accounting, there are situations where mining product is profitable from a marginal cost perspective, but when you fully burden in capital and other fixed costs, the project as a net becomes unprofitable – we are seeing this somewhat in the natural gas industry presently. Eventually the money-losing producers quit producing and/or demand will increase and you will see a price spike since bringing capacity online is not a speedy process.

This has strategic implications with respect to crude oil pricing – Brent Sea crude has traded significantly higher than West Texas Intermediate, which would suggest that North American markets are somewhat more insulated from what is going on across the Atlantic Ocean.

In terms of market implications, it remains to be seen whether this geopolitical unrest is going to flare up into something bigger (and thus interfering with trade more than it has) or whether it will be a blip that will pass by – and the major indexes continue their seven-month uptrend without any significant correction.

Note that I will be taking a little break and will not be posting for the rest of the week.

I know very little about the ocean freight industry other than that internationally based companies, such as Dryships (Nasdaq: DRYS) have exhibited considerable volatility as the market has boomed and now crashed.

The big difference between ocean shipping and land shipping is that inexpensive freight transit can only be performed by railways, while oceans are only limited by the number of ships you can manufacture and port facilities. Trucking is not commercially competitive with rail freight (except for delivery to the “last mile”) and as energy prices continue to rise, rail will continue to be very relevant in the future.

The two large Canadian companies in this space are CN Rail (TSX: CNR) and CP Rail (TSX: CP), both of which are trading at healthy, but not ridiculously overpriced valuations.

Although a single headline does not make markets move, it is something to be cautious about. The price of gasoline has not reached the mania level that it did back in 2008; however, it may reach that again in 2011.

I noticed while reading the latest financial pornography, mainly the five or so Canadian-related websites that attempt to sell advertising that they are having a “top four” stock contest. While these are purely for fun and have no bearing on reality unless if people invest real money in their convictions, I do notice that oil-related companies are starting to become about as prevalent as investing than gold-related companies.

Although in the long run I believe that the easy oil is gone, oil is still a cyclical market and is still bound by the economic constraints of how the marketplace works – with high capital costs, there are times where each individual company would see it rational to produce product above marginal cost but below fully burdened costs, leading to a situation where you have the underlying commodity trading below the fully burdened cost.

You see this happening today in the North American natural gas marketplace.

The contrarian pick would be to long natural gas and short oil, but this seems too obvious and too soon. One of the most dangerous aspects of investing is knowing when to exit the party, and an early departure to the party at this point will likely lead to plenty of gains being abandoned in the name of safety. When everybody runs for the exits, it will not be pretty.

However, if you’ve survived with your capital, you will be sitting pretty to pick up the capital-hungry entities that will be left standing and will receive a good risk/reward ratio for your patience.

Every day when I look around me, I see people in their automobiles, and I see trucks on the road, and airplanes flying in the sky. While the sample of one is statistically insignificant, when you start to think about world-wide demand for concentrated portable energy (which is what crude oil represents), coupled with the increasingly high costs to mine supply, leads one to suspect that hedging their energy consumption in the form of owning energy assets would be a prudent portfolio decision.

This isn’t new – I have been discussing this for the past couple years. I believe in crude much more than gold in terms of hedging your purchasing power.

Large-cap oil sand companies like Suncor (TSX: SU) and Cenovus (TSX: CVE) are highly correlated to the price of crude oil. They also have significant bitumen reserves which become increasingly valuable as the price of crude rises. Due to the nature of the financial structure of these companies, they are not going to double overnight, but they will retain their value as long as you believe in the stability of the Canadian and Alberta governments.

Companies with oil assets outside “safe” jurisdictions (e.g. Venezuela) involve much more risk, hence you will find them cheaper.

There are also some other smaller cap companies in the oil sands space that are worthy of consideration, and they contain a bit more financial leverage which would result in potentially larger gains.

The oil sands is a huge strategic advantage, especially as fossil fuel mining becomes progressively more difficult. In particular, transport fuels are going to face huge demand pressures as China and India continue their very high economic growth.