The world continues to consume more oil than it can currently supply. The ongoing correction in crude oil prices is opening the door to one of the best entry points for investors in more than three years as most companies trade at or near their 52-week lows and pay some fat dividends in excess of the broader market and Treasury bonds.

The world is not heading into an economic recession and investors should accumulate depressed energy shares now ahead of a major bottom.

Poor Correlation on the Way Up

As oil prices raced to a record high of $147 a barrel earlier in July, the majority of energy stocks trailed the blazing pace set by oil futures. Even as oil prices went into overdrive starting last spring, energy shares struggled as the bear market in global stocks applied downward pressure on the complex. Major U.S. and international oil companies had gained only 3.5% from January 1 to July 11 when crude oil peaked compared to a blistering rise of 63% for oil futures. Over the same period, the S&P 500 Index tanked more than 10%.

Admittedly, the recent peak in oil prices was extreme if not symptomatic of a short-term “bubble”.

Commodities have been the prime recipients of a global institutional boom through the creation of exchange-traded-funds and an influx of hedge fund money seeking exposure to one of the few remaining profitable segments of the market in an otherwise dismal year for equities and bonds. The “big trade” over the last 12 months for hedge funds has been riding the wave in commodities, including oil and shorting or betting against financial stocks. That trade violently reversed last month.

Another dose of bad news for commodities lately is the dollar’s rapid recovery. With the dollar in a freefall over the last few years investors had scrambled to hedge their portfolios against rising inflation and a decaying currency. But that trend is over, at least for now.

Bear Market or Correction?

From its high in early July the benchmark Reuters-CRB Index has declined 19% while crude oil prices have tanked 23%. Other commodities have declined even more. Oil stocks, as measured by the Spiders XLE Index (XLE) are down 22.5% from their highs while the Dow Jones Oil Equipment and Services Index is off 21% from its best level.

Commodities, including oil, are in a correction and not at the cusp of a bear market.

The market is right to discount a slowing global economy this year as credit problems and stagflation spread to overseas economies; but it’s wrong to assume that the bull market in oil and most other commodities is over – not with short-term cash rates still below the rate of inflation and global money-supply growing in excess of almost 20% year over year, according to Grant’s Interest Rate Observer.

In its fight to control deflation in housing and bank credit the Federal Reserve will continue to pump the financial system with more money. Massive government bail-outs don’t come cheap. Over time, inflation, which is now moderating, will make a comeback.

And what about the dollar?

Just because the dollar is soaring doesn’t imply that trend will last, either. The Fed is not going to hike lending rates for at least another 12 months and foreign central banks won’t start cutting rates until inflation eases. The dollar, though in a bear market rally now, doesn’t have interest rate support by the Fed while the economy remains mired in a severe slowdown or recession across several important industries.

At the very least I expect the rate of dollar appreciation to slow over the next few weeks as profit-taking arrives and more signs of credit contraction plague the domestic economy. If anything, I’m expecting the Fed to cut, not raise, interest rates in 2009. That won’t be bullish for the dollar.

Thank God for China!

The energy sector is not as reliant on U.S. domestic consumption compared to ten or twenty years ago. And compared to the last oil shock in the 1970s, China was barely a factor in global consumption; today China is the primary reason why most commodities are in a secular bull market. That’s also the case regarding oil. It’s a primary demand-driven trend that won’t end any time soon.

The Chinese are becoming big global consumers. Total domestic retail sales in China grew a formidable 23% year-over-year through July compared to just 0.1% in the United States. The Chinese are avid consumers and of course, major exporters. The economy will continue to grow and that means the consumption of raw materials, including oil.

Compared to the 1970s when China was barely a dot on the consumption map, it’s devouring excess supplies of most commodities – especially on corrections or when prices dip lower. The Chinese hoard commodities during big corrections.

Barely any Demand Destruction in China

Investors fail to understand that the primary source of new oil demand is from the emerging markets, not the United States or Europe.

According to Merrill Lynch, oil demand growth in the emerging markets has never contracted year-over-year in the modern era. Although demand destruction has started in the emerging markets the overall trend for consumption remains long-term bullish.

Total oil supplies remain in deficit to the tune of roughly 2 million barrels per day or 87 million barrels of demand compared to 85 million barrels of supply. That discrepancy in supply and demand has been consistent for over a year and remains threatened by supply bottlenecks in many oil producing markets and threats of regional conflicts.

Oil Stocks are Cheap

A stable dollar is a plus for world growth since it helps to moderate inflation for many emerging market currencies, which should stimulate economic growth and demand for oil and other distillate fuels at a time when the global economy is slowing.

Provided that U.S. interest rates remain low for the foreseeable future, and they will, global economic growth will continue. Oil prices will find a floor and that makes energy stocks a great buy at these distressed levels.

I’ve been busy accumulating oil and energy services companies over the last few weeks following big price declines. Most oil stocks are not priced for $75 oil yet alone oil prices north of $100 per barrel. And compared to banks, energy stocks have real assets and real earnings!

Cash-flows for the majors in the United States, Canada and Europe are bulging and dividend payments are still being increased. These stocks now trade at 52-week lows and should form a bottom over the next several few weeks or sooner as oil prices finally trough.

Lower Rates Ahead in 2009

To reiterate, the global macroeconomic picture is nothing like it was in the 1970s. This is perhaps the most significant bullish point I can make amid a big correction now for raw materials. We don’t have skyrocketing interest rates and double-digit inflation.

China is now a major player with regards to commodity consumption. It was almost insignificant thirty years ago. Thank goodness for the Chinese. If they didn’t exist the bear market in U.S. stocks and bonds would be far more severe, the dollar would be near-worthless and commodities would be trading in the basement.

Provided that global interest rates remain historically low and the United States and Europe can eventually stabilize the ongoing credit crisis then global economic growth should reaccelerate later in 2009. A stable dollar will also mitigate inflationary pressure globally and that’s a positive development for new consumption. Also, slowing growth and lower commodities prices now will eventually open the door to central bank rate cuts in 2009 – a boon for commodities.

The time to buy or accumulate new positions in the energy sector is now. The oil majors and the oil drillers have been smashed hard over the last six weeks and offer great value in an otherwise sluggish earnings landscape. Earnings for the oil majors and the drillers will continue to flourish even at $75 oil, which I don’t expect unless the Chinese economy collapses. And that won’t happen in 2008 or 2009.