Commodities | Sep 19 2006
By Rudi Filapek-Vandyck
“Even the deadest of all dead cats bounce if they are thrown down hard enough.”
US based trading guru Dennis Gartman does not always paint a pretty picture in his daily newsletter, but his market insights are often of an invaluable quality.
After nine days of pure carnage the falling spot oil price has come to a pause in the US$62-64 per barrel (WTI) region. So is this it? Is this the bounce that comes from the deadest of all dead cats?
Gartman certainly seems to think so. In his latest update on matters he concludes: “[oil] is the deadest of dead cats, and its bounce is the barest of margins.” Gartman is not a fan of peak oil (not a fan at all!) and he believes this market may move further south still, suggesting such a minor bounce after such big price falls does not bode well for the immediate price prospects of spot oil.
Last week, chartists at Barclays Capital said they remained positive about the underlying direction of the oil price as long as technical support at US$63 per barrel held its ground. Borrowing from Gartman’s lexicon, one could conclude that oil has held its ground “with the barest of margins” – so far.
However, not everyone is convinced the long term uptrend for oil has remained intact.
Last week, when the price of oil was still coming down like a dead bird from the sky, Australia’s respected investment expert Ian Huntley reported his view had changed regarding the price outlook for oil.
I think the heat is out of the oil market, Huntley wrote to his subscribers, adding he no longer adheres to the peak supply thesis for traditional oil. Huntley now believes there will be enough additional oil production coming on line to alleviate the supply pressures from the recent past, citing the current explosion in natural gas development as a prime example of this. (A view strongly endorsed by Gartman).
Adjustments are taking place and while the process will evolve slowly it nevertheless is there and impossible to ignore, Huntley seems to suggest. However, “there’s nothing like US$70 oil to do the trick”. Huntley believes spot crude oil is likely to stabilise in the US$60 area – for now.
This would be “not that bearish!” he concludes.
Smith Barney Citigroup’s US based oil specialists Doug Leggate and Jason Smith disagree with (nearly) all of the above. Both are looking for spot oil to fall to the mid-US$50s and the basis for their forecast is technical analysis.
Why technical analysis? Because the impact of big investment funds on the oil market has increased considerably over the past few years. These funds are believed to take direction from technical analysis. That’s why.
Leggard and Smith are not your average spec cowboys in the market. They actually spent time and effort in analysing the oil market over the past few years and have come to a few interesting conclusions, such as that traditional market fundamentals have failed miserably in predicting the oil price in the recent past.
Leggard and Smith reject the often cited “risk premium” which has been used widely to explain why spot oil was often higher priced than market fundamentals could explain. Instead both experts offer investment funds have always played a role in the market, but their impact has increased markedly. It doesn’t take too much imagination to assume that this has translated into higher prices than would otherwise have been the case.
Currently, investment funds are the number one dominant incremental buyers of oil futures accounting for more than 50% of the market, both analysts put forward. They draw from this the inevitable conclusion that “the technical outlook would then become somewhat self-fulfilling and thus a critical lead-indicator for near-term oil prices”. (In other words: there’s no room for discussion whether technical analysis is better or simply rubbish. The big fundies use it, they represent the majority of the market and it therefore becomes by default a factor to take into consideration).
But the technical picture is still looking alright, right? (Well, that’s what Barclays tells us). Citigroup chartists must be using different charts than their colleagues at Barclays because it is their assessment that oil has likely entered bearish territory from here on.
Citing oil’s recent break below a 55 week moving average of US$66.40, the oil specialists report oil is likely to have breached “a critical technical level”. The next major support is to be found… into the mid-US$50’s!
Having said this, Citigroup also believes oil’s price prospects have weakened from a fundamental perspective. Leggard and Smith talk about “fundamentals also point to a softening price outlook near term”.
They cite weakening refining margins, the likelihood of lower crude oil demand, “while long-awaited increases in non-OPEC production look likely over the next two years leading spare capacity higher”.
No doubt, BIS Shrapnel chief economist Frank Gelber would be nodding his head, while smiling from ear to ear. Gelber is not a big fan of “this time is different” theories, arguing at the business forecaster’s recent conference in Sydney that oil too was simply experiencing a classic scenario of producers being caught short by a sudden spike in demand (China) following years of underinvestment.
As supply is likely to catch up with demand over the next few years, the world will again see the price of oil come down, and sharply, Gelber predicted. This is because speculators expected to jump ship once the uptrend disappears.
The sad side-effect from all this is that oil stocks may well remain undervalued throughout the process. Both Citigroup analysts believe the majority of oil stocks in the US deserves a higher share price, but with spot oil likely to head south, this situation is unlikely to change anytime soon, they suggest.