$50 Oil Is Now The Buzz
by Dr. Joe Duarte
|Tuesday, August 10, 2004
Crude oil futures were trading above $44 in pre U.S. trading.
News of more strange behavior in Russia with the Yukos crisis, and reports that Iraq has stopped some shipping operations in its southern oil fields, led to new highs in crude oil prices.
Oil stocks bounced back on 8-9, but were not that impressive, and are still off of their recent all time highs.
As we watched Kudlow and Cramer on CNBC, we saw an interesting interchange. Larry Kudlow, T. Boone Pickens, and highly quoted and visible Alaron Trading analyst Phil Flynn, all agreed that oil is going to $50. Boone Pickens was certain that it would happen before 2005.
Now, Flynn and Pickens are stout oil guys that know their business. And far be it for us to argue with them, much.
Yet, as we see it, all alone in the wilderness, those two stalwarts are not alone in their expectations. And, with all due respect to Mssrs. Pickens and Flynn, complete consensus is never a good sign, in any market, but especially, when a market is as heated up as oil is at the moment.
How High Can It Go?
Here is a wild quote from Bloomberg's after market commentary on August 9: '[``There is no limit to how high crude oil can go,''] said Carl Larry, an associate director of energy futures at Barclays Capital Inc. in New York. ["There is too much demand and terrorism. There are problems in Iraq, Russia and Venezuela that threaten supply."]
Here is another off the scale comment from Bloomberg: "Deutsche Bank's oil strategist Adam Sieminski said in a note today that oil prices may temporarily rally [``toward $100''] if an accident, disaster or sabotage cuts supplies from two major oil- producing countries at the same time."
What we're seeing, is that traders are now almost unanimous in the expectation that crude oil will hit $50 per barrel, and that it may be soon. Some, as above are expecting even higher prices. And contrarians know that when all agree on one thing, it's just a matter of time before the opposite becomes the norm.
We are not discounting that oil can go to $50 per barrel. Our question is this though: what does the market do after it hits $50?
And if oil is about to hit the stratosphere, why are oil stocks not keeping up? After all, many of them have rung up record profits in the past few quarters.
It doesn't add up.
Oil, contrary to popular belief, a supply driven market. And for now, supplies are, at least in the short term, moving higher, although OPEC is maxed out, and there is little if any slack in the system. Higher supplies, even if demand stays stable, means that the market will be balanced. And balanced markets don't lead to higher oil stock prices, since those companies make money by raising consumer prices beyond their own rising business prices. A balanced market cuts into the oil companies' crisis premium. And that leads to oil stock selling.
To be sure, all kinds of negative things are possible. Terrorists can hit major oil installations, or deliver on their threat to the United States. Suppliers can suddenly shut down due to a political crisis, such as may be brewing in Russia, and in Venezuela, where the Chavez referendum vote is scheduled for Sunday. Or any other various and sundry problems can develop.
It is never wise to fight the overall trend in the market. And crude oil futures are definitely on a trend, toward higher prices until proven otherwise. The problem is that the oil stocks have gotten off the train. And traditionally that means that we are in a technical negative divergence. Negative divergences usually resolve to the direction of the stocks, not the commodity.
What that means, unless it is corrected, is that oil futures may be on their swan song run, and that they could make a top sooner than most expect.
To be sure, anything is still possible. But this much is true. Despite rising crude prices, the oil stocks are still way below their recent highs. And the stocks in our energy trading portfolios have all been stopped out, many in rising volume, suggesting that big investors have been taking profits. To have played the oil stocks from the short side would have been akin to committing trading suicide.
That is not a bull market, at least not one that if it follows normal behavior, can last. The current market is a market with rising volatility that is best not touched by individual investors unless and until it settles down.
The Philadelphia Oil Service Index (OSX) remained near 106, with 100 providing support. A strong close above 112-115 would likely signal a new rally here. A break below 98 its 200 day moving average, could send it plummeting to the 88 area in a hurry. For more details on trading the energy sector visit our energy timing page, featuring our highly effective OIH timing model and our Top Ten Energy Stock List.
The Amex Oil Index (XOI) remained near the 630 area, after failing to break above 660. The 610-627 area is key support, and has been penetrated. This is still a crucial juncture for the entire oil sector, as a continued failure in the near term could lead to a major top forming. A close below 600 would be a very negative technical development. For immediate analysis, including stock picks, and the latest in technical analysis of the entire energy complex, our subscriber section has a full complement of recommendations in oil service and the rest of the energy complex.
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Dr. Duarte's book predicted many of the current developments in the economy and the energy markets, and provides an excellent set of benchmarks and trading lessons for what could be in store for the future.