Tuesday, January 13, 2015

$0 Oil, Good for the economy?

Update: WTI broke under $45 at time of posting, but we have dropped to under $44.50 in less than an hour.

I'm so SICK of hearing that lower oil is good for the economy. That means if we go to $0 oil, the global economy must be BOOMING, right?!

Please cut the crap, oil has already crashed more than 50% from recent highs. When are we going to admit that ridiculously cheap oil means that there is clearly something deeper wrong?

I see a lot of human pin cushions trying to catch the falling knives here. I swear, it is taking a lot of self-restraint to keep me from joining the rest of everybody catching all of these knives. I just have to keep reminding myself that "I don't know anything".

To be frank, oil is very oversold. It is "relatively" cheap by quite a few standards. The best thesis that I have for Oil bottoming is that the USD tops out and starts reversing from here.

I am a very strong believer that the USD will not continue it's epic and meteoric rise to infinity. Long USD is the second biggest trade these days that every father, mother, grandmother and step-son has (this is the first). If the USD does top out here, it will provide relief for Oil and that would help it form a base.

The other indicator pointing to a bottom in Oil is the Gold-Oil Ratio (GOR). The GOR is reaching historical extremes, which either indicates that Oil is going up from here, or Gold is gonna come crashing.

However, Gold has already crashed 40% from its peak price of $1920 in Sep 2011 until Nov 2014. This is very in line with previous gold bear markets and I really doubt more extreme downsides from here considering the timeframe. Longer bear markets have not been deeper than shorter ones, which makes the 40% drawdown fit perfectly in the analogue if updated - almost too perfectly. Anyway, that weakens the GOR thesis for an oil bottom.

Which means the GOR really might be pushing to extremey extremes this time.

What else causes me to believe that there is further downside possible is one part fundamental, one part technical. Fundamentally, I think we still need more time for hedges to expire and wipe out a lot of suppliers. Technically, I think we are missing capitulation. Gold had its capitulation back in June 2013 and since then we haven't gone everywhere except made a beautiful basing pattern. A darn long 1 year plus basing pattern if you ask me, but a basing pattern nonetheless.

As you can see from the chart above, we are clearly oversold in Oil by all the leading indicators that I use. However, there is no capitulation yet. That is not to say that a capitulation is needed to form a bottom. No, that does not always happen. However, if there was a spike, then it would help check a lot more boxes to give more weight to the possibility of this being the base.

The last indicator that I am looking at is the Baker Hughes rig count.

Though there is a time lag between oil bottoming (happens first) and the rig count bottoming, the drop in the rig count does not seem done yet, in fact, it barely seems to be getting started!

To be clear to all, I am not an oil expert. And I don't claim to be one at all. If I was, I'd be the head of commercial hedging for XOM or RDS. Heck, I don't even TRADE oil with CFDs when I'm bored. I trade tons of other things, like silly beans and barbaric relics, but I don't even touch this black sticky stuff. Why? Exactly because I don't think that I am expert at all. I have no experience, knowledge and therefore no edge. However, energy (oil) is very important to the rest of the economy. It is one of the key inputs to any product. No input = no output. That is the reason why I am watching it with much interest. To me, it sheds some light on global macro. (hint: looks really bad moving forward)

I think we are nearing a base, but I really don't see us basing at this price or at this time. Perhaps another few weeks down the road. I am still not convinced, and until I am, I don't see any rush to run around catching knives. Keep an eye out on a USD reversal, a strong spike down and finally rig count stabilizing. Those things happening in conjunction is my strongest thesis for a base.

My opinion, your money guys. Just your average random crazy person rambling his thoughts outloud.

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