Rudi On Thursday

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Crude oil prices have come down considerably this week, but they are still trading around US$136 per barrel on Wednesday afternoon. Those who have been reading the technical insights by the team of chartists at Barclays Capital lately know this means the price of crude oil has now dropped below the first level of support, which was located at around US$138.

So whereto from here?

Well, says ANZ senior commodity strategist Mark Pervan, a retreat is nothing more than what could be expected. Pervan has been signalling for a while he thought crude oil was looking a little tired and there were plenty of market signals (for those who wanted to see them) that a retreat from dizzying highs in the mid-US$140s was near.

Pervan is of the view the short term outlook will be for choppy trading sessions, but the overall trend should be down and ultimately result in a lower oil price by year end. Demand destruction will become increasingly visible he says, in addition China will buy less oil once its strategic reserve is filled and the Olympics over and done with.

But don’t expect any dramatic declines, says Pervan. The oil market remains too tight for such a scenario. (Pervan is also of the view that the US dollar is at or near its lows and this will make any further price advances for crude oil a much more difficult task).

One of our own contributors who had dared to suggest that crude oil was looking “toppy”, the TechWizard, instantly jumped on the opportunity this morning to send in his latest views based on technical analysis. The Wizard believes, as suggested in a story on commodities earlier this week, that large funds and hedge funds have started to run for the exits and this has caused the oil price to correct from north of US$145 to US$136 per barrel in a relatively short time frame.

From a technical perspective, says the TechWizard, crude oil has now closed (on a daily basis) below its 20-day moving average (MA) and those with a little knowledge about technical analysis know this is seldom a sign that can be ignored. Regardless, the Wizard sees continuing good support at US$133 and were that level to give away there’s always still the bottom Bollinger band, currently at US$131-130, for the next level of support.

The main conclusion I would draw from the TechWizard’s analysis is that there’s plenty of support around at current price levels, increasing the odds that crude oil won’t weaken much more from here. For the trend to reverse into negative, says the Wizard, crude oil has to remain below the 20-day MA for a while and this will cause the moving average itself to turn south. However, if this doesn’t happen, any weakness should turn out an outstanding buying opportunity.

Technical chartists at Danske Bank have a much more sober outlook for oil. They noted yesterday crude oil futures have now been trading in a bullish trend for more than 70 weeks (!) and this in itself would seem sufficient reason for some tiredness to kick in. There’s early divergence between RSI (that’s relative strength index to you and me) and price movements on both weekly and daily charts, report the chartists, who dare to call crude oil “heavily overbought”. A correction thus seems but logical.

Danske chartists are not as cautious as the TechWizard. They believe the coming correction (or should that be “current” correction?) will take the price of West Texan Intermediate possibly as low as US$123.42 per barrel, maybe even further to support at US$118.22, before another leg up will commence. Danske believes crude oil is currently supported in the US$135-region, and that is exactly where it has found support yesterday and today.

In case you wondered: the above mentioned chartists at Barclays Capital predict crude oil is likely to range trade from here and as long as the price holds up above US$131.33 (trend line support) the prospect of a run towards US$150-155 per barrel remains intact. Barclays would only turn worried if and when crude oil would fall through US$120, but that is currently a long, long way off.

Danske Bank’s commodity specialist, Arne Lohmann Rasmussen, has weighed in the “speculators versus fundamentals”-debate by stating that while speculators can dominate the price direction of commodities in the short term, over the longer term market fundamentals will always prevail. As such, Rasmussen believes crude oil’s price trend remains up, but first we have to get rid of some “fluff”.

In the shorter term, suggests Rasmussen, the price of oil has simply run too far ahead of market fundamentals. A price correction thus seems but a logical result. Says Rasmussen: “Although we have several times been surprised by the strength in oil prices, we now dare to forecast that prices will stay at current levels in Q3, and edge lower in Q4 and in H1 2009.”

Wait a minute! Didn’t Rasmussen just say the trend was up over a longer term? The following paragraph explains it all: “Looking beyond our usual 12-month horizon, we would not be surprised to see new record prices, as the market looks very tight in the medium term. For now, though, we think that oil prices have “run out of energy!”. Our long-term view implies that one should seriously consider going long oil/hedging oil exposure if prices dip below USD125 a barrel.”

The other day I heard one expert saying US$80 per barrel had now become the “new US$40”. Rasmussen, however, suggests the recent shift in market fundamentals has been much more severe. He suggests US$125 has now become the US$40 from yesteryear.

Economist/strategist Jeff Rubin at CIBC World Markets has even gone a few steps further. Rubin’s latest update on “global matters” sees him forecasting an average oil price of US$150 per barrel for next year and of US$200 per barrel for 2010.

To be honest, I would be no less than stupefied if it turns out such price developments would be even remotely possible; a year ago a barrel of crude oil cost US$72 – so Rubin is effectively saying the price will increase by 200% in less than three years and oil consumers will still happily pay for it. Also, Rubin’s US$200 is an average for the year, which makes one wonder: what kind of peak prices is he thinking of?

There’s another element in Rubin’s strategy update which I found very interesting. It’s something that caught my attention a while ago, but I haven’t found the time nor the right opportunity yet to delve into this, but I think it is something investors in today’s markets should be aware of. (Especially since my remark at the bottom of this week’s Weekly Insights about long term investing has already generated various responses from readers).

Taking fierce price developments for crude oil into account for the next years, Rubin has spontanously lowered his projections for share markets. No surprise here as the inverse relationship between share markets and oil prices has been pointed out by myself for many weeks now. However, when I had a deeper look into Rubin’s projections for the next two years I discovered that, with oil prices expected to climb and climb and climb in the months and years ahead, every sector in the US economy will either border on recession, experience a recession, or experience a very deep recession – every sector with exception of the oil sector, of course, and materials.

And the same applies to the Canadian economy.

Now, I do realise Rubin is painting a rather extreme scenario (I haven’t seen anything similar elsewhere as yet) but he is nevertheless projecting a scenario he believes will materialise. This is not about one economist’s theoretical exercise. All clients from CIBC World Markets have received this update and are being advised to restructure their investment portfolio in line with his recommendations.

What does this tell you about the possible prospects for the Australian economy?

It is with the above scenario in the back of my mind that I suggested in this week’s Weekly Insights that many an investor who thinks he’s scooping up shares in ResMed ((RMD)), Harvey Norman ((HVN)), PaperlinX ((PPX)), Boral ((BLD)) and ANZ Bank ((ANZ)) -to name just a few- at absolute bargain prices today, might find that in two years from now these shares were not such a great bargains after all.

Without dragging this public discourse into too much detail (and we all know expectations are by default just that, they will be revised at sometime in the future) but let’s for a moment consider Rubin’s projections are correct and the future is for higher, or even much higher prices, for oil, base metals and other commodities, and for agricultural products regardless of low economic growth in developed economies. There is no doubting this will significantly reshape the world as we know it today. It will also significantly impact on investment returns in the years ahead.

To put this in a CIBC context: if you agree with the above painted future you should now rebalance your investment portfolio towards a heavily overweighted position in oil and gas and related services, in combination with exposure to fertilisers (to cover the agri component), gold, other metals and chemicals.

And simply forget about all the rest.

This is not what CIBC’s latest strategy update suggests. But given the heavily lopsided economic balance that is being put forward, I would dare to question the merit of being “underweight” financials, or “underweight” consumer discretionary, or “marketweight” utilities.

Let’s face it, every company not in oil is going to find the going extremely tough and given the subdued economic outlook all this translates into there will simply be no opportunity for PE expansion on share markets for companies in non-oil related sectors. So why would anyone want to own a stock like Goodman Fielder ((GFF)) if you suspect input costs are likely going through the roof while opportunities to pass any of those costs on will remain limited?

Rubin has also advised investors should hold more in cash than usual.

With those thought provoking ideas I leave you all to it this week. Till next week!

Your editor,

Rudi Filapek-Vandyck
(as always firmly supported by Greg, Grahame, Sarah, Chris, Todd, Paula, George, Pat and Joyce)

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