Commodities may be down, but they’re not out – and they shouldn’t be out of your portfolio, either.

As the investment director for Money Morning, I’m invited to a large number of speaking engagements each year. It’s something I enjoy, and it’s quite useful, too, for the questions that I get tell me a great deal about investor sentiment and the general tenor of the financial markets. The same is true for the questions I receive daily from our readers.

Lately, the most intriguing questions have dealt with the price of oil and other key commodities. It’s a topic that’s clearly on a lot of people’s minds so I thought I’d share some of them with you today.

Q: With crude oil prices down more than 75% from their record high set in July, do I really need to worry about “peak oil.”

A: Let me be blunt. Producers are operating near maximum capacity every day with 89.5 million barrels per day. We’re using 89 million barrels per day. That means there is essentially no excess capacity anywhere – period. If you factor in war, routine maintenance of pipelines or refining facilities, and diminishing supplies, we’re probably already running at a deficit even though current data does not yet reflect that. There is a very high probability that in the near future demand will outrun supply – and by that I mean permanently outrun supply.

I don’t think this is “just” peak oil. But I do think it’s the investing opportunity of our lifetime.

Q: That sounds alarmist. What about other commodities?

A: There’s a difference between being alarmist and being prepared – and, in this case, we’re talking about the latter especially when it comes to potential profits.

We are in the initial stages of a fight to the death for energy supplies and many other commodities – most notably potable water.

As I’ve noted for years, and as Money Morning detailed yet again in an analysis just last month, China, among other countries, is using its huge currency reserves – and the financial weakness of rivaling other global players – to lock up long-term supplies of commodities. By any stretch of the imagination, I don’t think this is the last we’ll see of this kind of thing.

The bottom line is that the outcome of this battle will affect every nation on earth. Absent truly fungible substitutes, it’s reasonable to expect to see oil nationalized at some level within our lifetime, and the first armed conflicts over water somewhere on the planet possibly as soon as 10 years from now. Certainly there is going to be economic conflict over those two things and on a level that is presently unimaginable. Depletion is happening at a far faster rate than most people realize.

Q: But oil’s still cheap.

A: It’s always been cheap – cheaper, in fact, than a cold soda or bottled water. But at a time when market forces are inevitably diminishing the supply, even as demand continues to grow, we’re looking at a one-way trip over time.

The average American uses two times the amount of oil used by each European, four times the amount used by each Japanese consumer, 12 times their counterpart in China, and 30 times the amount used by the typical consumer in India. And that’s at a point in time when nearly 4 billion people live in complete poverty without the stuff we take for granted…like oil and water.

Supplies are destined to shrink.  And until we can find replacements, we’re stuck with what we’ve got – there’s no more of it.

Q: Isn’t the world working on substitutes as fast as they can – having been shocked by record prices of $150 a barrel?

A: Yes. And they’re making good progress. However, even if substitutes were found tomorrow, we still have to replace trillions of dollars worth of manufacturing and infrastructure processes that have to be changed completely. Some studies I’ve seen suggest that oil is used in more than 60,000 manufacturing processes and it’s much the same with water, in particular.

Even the most wildly optimistic estimates suggest that changing to new technology may take another 30 to 50 years to work through. In the meantime, oil is set to run out 35 years from now using the highest-reserve-level calculations available – and that assumes no demand growth and no population change. It’s even worse when it comes to water. Some predictions suggest that by 2050 nearly 7 billion people will live nearly waterless lives.

Q: That’s pretty forceful thinking.

A: I’ve always operated under the philosophy: “If not now, then when? If not you, then who?”

As the investment director of Money Morning, my job isn’t to “force” anybody to think a certain way, or to take a certain action. It’s to analyze the best data available to me, to make the appropriate recommendations, and to provide you with the insights you’ll get nowhere else.

I think we have the opportunity to invest in a group of “real assets” (which I define as oil and other key commodities) at a point when supplies are declining as demand is escalating. That combination suggests very rapid appreciation as demand eventually overwhelms production in the next few years. It’s a rare combination, and that’s why I say it may be the “profit opportunity of a lifetime.”

This reminds me of a conversation that I had with my colleague Jim Rogers, not too long ago, when the legendary investor observed that “real assets represent real wealth.”

I agree. And you will, too.

[Editor's Note: The ongoing financial crisis has changed the investing game forever, making uncertainty the norm while simultaneously creating a whole set of new rules that will help determine who wins and who loses. Investors who ignore this "New Reality" will struggle, and will find their financial forays to be frustrating and unrewarding. But investors who embrace this change will not only survive - they will thrive.

As his short essay on long-term profit plays today illustrates, Money Morning Investment Director Keith Fitz-Gerald is constantly on the lookout for ways to turn these seeming negatives into positives that can create market-beating profits. In his new service, the Time Trader Pro, Fitz-Gerald details investment recommendations based on a proven quantitative system of analysis that was previously only available to the so-called "uber-rich." The strategy allows him to recommend positions that simultaneously reduce an investor's risks, as well as his purchase-price points - all of which boosts the investor's returns.

While most investors lament the damage the financial crisis has wrought, Fitz-Gerald says that his research into "chaos theory" and his on-the-ground analysis of investment plays in fast-growing China has made him realize that we stand on the precipice of "The Golden Age of Wealth Creation." And the strategy that he's deploying is perfectly suited to the kind of whipsaw market we're facing today. Check out our latest report on these new rules, and this new market environment.]
News and Related Story Links:

• Wikipedia:
  Peak Oil.

• Money Morning Market Analysis:
  What Companies Are Profiting From China’s Commodities Crusade?

• Energy Bulletin:
  Why does fungibility matter (and where did it go)?

• Google Definitions:
  Potable Water.

• Investopedia:
  Real Assets.

• Money Morning Exclusive Jim Rogers Interview From Vancouver (Part I):
  Exclusive Interview: Jim Rogers Predicts Bigger Financial Shocks Loom, Fueling a Malaise That May Last for Years.

• Money Morning Exclusive Jim Rogers Interview From Vancouver (Part II):
  Exclusive Interview: Jim Rogers Continues to View China as the World’s Best Long-Term Profit Play.

• Money Morning Exclusive Jim Rogers Interview From Singapore (Part I):
  Jim Rogers: More Pain for the Greenback, and the Failure of the Federal Reserve.

• Money Morning Exclusive Interview From Singapore (Part II):
  Jim Rogers: China’s Economic Advance is All But Unstoppable

• Products:
  Keith Fitz-Gerald – Time Trader Pro

Every president has a defining moment when the American people, and indeed the world, recognize that he’s badly out of touch with some aspect of reality.

I can’t help but think that President George W. Bush ["Dubya"] has just had his moment as I watch him muddle around an unsympathetic Middle East this week, pushing for lower oil prices.

The market just isn’t going to let this happen.

Turning on the petroleum spigots as he’s requesting isn’t going to solve the problem. Indeed, we don’t even believe that a solution exists.

Here’s why.

The oil markets right now face a situation known as "backwardization." This theory holds the future prices of a commodity will tend to rise over the life of the contract. The upshot: Near-term contracts trade at a higher price than the longer-term contracts. With oil, that means that near-month delivery contracts are priced more expensively than distant-month contracts. When this happens, market sellers have every incentive to sell as much as they can as soon as they can to maximize profits, since they know that future prices will be lower.

What this suggests is that no matter how much pushing, prodding or – in this case – begging Bush does, the markets are still likely to push prices higher in search of profits. The Saudis will want to sell all the oil they can at the current high price, and will do nothing to risk sending prices lower.

That means: No production increase.

Let’s walk through an example to illustrate how this works.

The February 2008 oil contract closed Tuesday at $91.65 per barrel, while the December 2008 contract settled $2.90 a barrel lower, at $88.75. Accordingly, the markets are telling oil sellers that it’s better to sell oil now than it is to sell it later.

At the same time, however, the market also is telegraphing to buyers that they can risk purchasing later at lower prices. But – and here’s the important part – the discounted price could push far higher as the delivery month draws closer.

When the markets exist in this state, it is in the seller’s interest to sell as much oil as they can as soon as they can, which makes what Bush is asking all the more absurd.

In 2006, Saudi Arabia produced 10.72 million barrels of oil per day. For purposes of illustration, let’s assume they sell it for February delivery. At $91.65 a barrel, that sale would result in a staggering $982.5 million in revenue. If they waited and sold it at the December 2008 contract price of $88.75, they’d receive $31.1 million less per day, or $951.4 million for their efforts.

You can do the math as easily as we can. Over the course of a year, that would net out to an "opportunity loss" of $31.1 million a day, or a net revenue shortfall of $11.3 trillion per year if the Saudis elected to sell later.

This means that by asking the Saudis to increase production in an effort to lower oil prices, President Bush is effectively suggesting that they shoot themselves in the proverbial foot to the tune of trillions of dollars in lost revenue – which is why we think there’s a not a snowball’s chance in Hades that anything other than a short-term reprieve might be possible.

But, just to play devil’s advocate for a minute, let’s assume that the Saudis decided to play ball.

Could they?

We don’t think so.

The massive Golar oil field, along with many of their fields, is in decline, and anecdotal evidence suggests that the Saudis have already reached their peak. Not only are they pumping massive amounts of salt water into their oil fields to sustain production, they’re also drilling enough wells in the region to make it look like a giant piece of Swiss cheese from the air. Add in the fact that the Saudis haven’t had a major new discovery in half a century, and we have all the ingredients for still-higher-higher prices – and that’s assuming they actually have what they say they do in the way of reserves.

However, there’s an increasing body of evidence suggesting that the Saudis have falsified their reserve counts since the 1970s, a scenario that author Matthew R. Simmons outlined in his book, "Twilight in the Desert: The Coming Saudi Oil Shock and the World Economy."

We’ve been talking for years about how this reality would ignite upward pricing pressure in the petroleum markets, but the possibility that the Saudis might not have been telling the truth and may actually be unable to meet global demand is something that the masses have only recently started to consider.

And trust us, when they do, the fear that there may not be as much oil as previously thought will send it up to the high-$100 price point I’ve been predicting faster than you can blink. And the price may go even higher than that.

Then there’s the Organization of the Petroleum Exporting Countries (OPEC). The Saudis risk upsetting the apple cart if they move in a direction contrary to other decidedly anti-U.S. OPEC members who want prices as high as possible for as long as possible. Many people think of OPEC as one big happy family. But the truth is that it’s often no better than a den of thieves who would just as soon cut one another’s throat as cheat on production quotas in search of still more profits.

So the bottom line is that Bush can saber-dance his way through the Middle East all he wants, but his machinations are likely to be viewed within the context of history as too little, too late. Perhaps he could have done something about this the last time he met with Saudi’s King Abdullah, and oil was still at $50 a barrel.

But now that oil is north of $90… forget it.

The Saudis, like other OPEC nations, have gotten used to higher oil prices and the global wealth that goes with it. They’ve also finally figured out that oil can be as much a political weapon as it is an economic one. For them, controlling the petroleum flow is better than having an army to field when it comes to assuming a more-important place on the world stage.

That makes it even less likely that they’ll lower oil prices out of the goodness of their hearts.

And that spells higher oil prices for years to come… even if by some stroke of luck we actually do find that snowball in Hades, and get a temporary respite.

News and Related Story Links:

• ABC News:
  Bush Asks Saudi King to Open Oil Spigots; Makes Personal Appearance After Public Rejection

• FinancialDictionary.com:
  Backwardization.

• Amazon.com:
  Twilight in the Desert: The Coming Saudi Oil Shock and the World Economy