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Just because the surface of the wood isn't completely smooth doesn't mean that the oil hasn't penetrated enough to seal the wood. For instance, if you took an open grained wood gunstock (Walnut has some open grain, but isn't real bad about it) and put it in an oil bath for 2 weeks, to let the maximum amount of oil penetrate the wood, and then let the oil dry (would take probably a month to dry completely), the wood would be effectively sealed, but the open grain would still show. Just the oil penetration would not smooth the wood out. That's where the wet sanding with the fine grit comes in. You fill the holes slowly with the oil/wood dust mixture until the surface is smooth. Both ways are effectively and equally sealed against moisture penetration, though the smooth wood is much prettier.
Linseed oil, as good as it is, will not prevent some water absorption by the wood. That's why you should occasionally put a few drops of oil on your hands and work it into the stock.
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