Why it’s Nearly Time to Short Crude and Stocks

Talk about a comeback!

After the worst yearly start in history, the US stock market closed at its highest level for 2016 last week.

The US S&P 500, the large-cap benchmark, rose 1.6% to close the week at 2,022.19 points. The Dow Jones Industrial Average Index, the institutional money index, gained 1.3%. It closed the week at 17,213.31 points — up for the fourth week in a row.

On this side of the Pacific, the Aussie stock market has surged in recent weeks. The ASX 200 benchmark index is trading around 5,200 points, up nearly 10% from its February low. Aside from the US stock market’s lead, commodities have aided the bullish run. The Sydney Morning Herald reported,

Commodity markets are showing signs that the worst may be over. Slightly better fundamentals have seen investors reduce the probability of downside risks, which has elicited a wave of short-covering,” ANZ analysts said in a note. “Sentiment has also picked up, with a glass-half-full approach being taken to weaker-than-expected economic data. This is not to say we are completely out of the woods.

In my view, commodities — and stocks — definitely aren’t out of the woods. In the short term, this week’s US Fed announcement is important. But this isn’t all. The short term story also come down to oil politics.

I’ll explain…

Blind Freddy can see the trend’s turned up

To start, you should know why stock the market’s booming. You’ll be a better investor.

Reviewing the story, while central banks have aided the stock market bounce, crude oil has been the primary driver. On this note, I warned crude was looking bullish in Money Morning on 1 March. I said,

Crude looks ready to break out higher. Looking at the daily charts, should Brent close above US$37 and WTI close above US$34 per barrel, it may be game on for crude. The rally probably won’t be huge. If it happens, crude should jump to US$40–42 per barrel — a major technical resistance level.

The timing of this call couldn’t have been better! Brent crude hit US$41 per barrel, while WTI surged to a high of US$39.02 per barrel last week. They’re up nearly 50% from their yearly lows.

There’s no question why stocks jumped when crude surged. According to Reuters, ‘U.S. crude and the S&P 500 have been directionally correlated on all but six trading days this year.’ If the correlation continues, stocks may break out to higher levels.

Remember, the trend is your friend. And smart punters realise that crude’s trend has turned up. The next resistance level is around US$44 per barrel. So, while we’ve become accustomed to lower prices, betting against crude’s — and the stock market’s — run may be a costly mistake.

Or, it may not…

When I was trading the financial meltdown of 2008/09, stock markets were in freefall. It wiped out trillions of dollars in wealth and destroyed investor confidence for years. Fund managers were still bearish when I was working for high net wealth investors in 2012–13! Yet, nearly everyone was wrong — the stock market started to take off to new highs.

For this reason, you’ve got to wonder, are we too bearish on crude oil? According to Market Watch, ‘Goldman Sachs analysts have [now] turned less downbeat on oil, saying “price lows may have been set.”

I admire Goldman’s positivity. But, unfortunately, the investment bank is likely wrong. In my view, while crude could go slightly higher in the short term, crude is already at MAJOR resistance. Plus, this is merely a bear market rally — it won’t last forever.

Has anything really changed?

Unlike the Global Financial Crisis of 2008/09 — when central banks started printing trillions of dollars (the ‘solution’) — the fundamental story for crude still stinks. There has been no ‘solution’ to crude’s nightmare. For this reason, crude — and stocks — should revisit the lows in the months ahead.

As it stands, the world is still very much oversupplied with crude — storage is at an 86 year high. The current bear market rally is purely speculative. Crude started to take off on the rumours that some OPEC and non-OPEC countries would ‘cap’ production after OPEC’s March meeting. Unfortunately, the meeting might not happen anymore. According to Reuters:

A meeting between oil producers to discuss a global pact on freezing production is unlikely to take place in Russia on March 20, sources familiar with the matter say, as OPEC member Iran is yet to say whether it would participate in such a deal.

OPEC officials including Nigeria’s oil minister have said a meeting would take place in Moscow on that date, potentially as the next step in widening an agreement to freeze output at January levels struck by OPEC members Saudi Arabia, Venezuela and Qatar plus non-member Russia last month.

But the biggest roadblock to a wider deal, OPEC delegates say, is Iran. Tehran feels it should be exempt from the agreement as it wants to recover market share it lost under Western sanctions. Kuwait said on Tuesday it will commit to the deal – if all major producers including Iran do so.

Iran, (and Iraq for that matter) have no intentions of capping production. Also, US shale producers — non-OPEC members — have said they’ll produce more crude when the price hits US$40 per barrel, which it has now.

If I’m right, crude’s merely found a temporary bottom — the major low hasn’t arrived.

Just another bear market rally

With this in mind, oil could rally a bit higher in the short term. According to Reuters,

Tehran has rejected freezing its output at January levels, put by OPEC secondary sources at 2.93 million barrels per day (bpd), and wants to return to much higher pre-sanctions production.

“Tehran wanted a freeze … for them to be based on 4 million barrels per day, their pre-sanctions production figure,” said one source familiar with the discussions. A source familiar with Iranian thinking agreed.

The issue is set to be discussed when Russian Energy Minister Alexander Novak meets Iranian counterpart Bijan Zanganeh. Novak is visiting Tehran on Monday, RIA news agency reported, citing the Russian embassy in Iran.

OPEC’s Gulf members favor meeting in the first half of April, in Doha or another Gulf city, a Gulf delegate said last week

Another OPEC delegate was more pessimistic, saying he expected no major progress until OPEC’s next scheduled meeting in June.

While Russia and Iran may strike a deal, seeing crude rallying higher, Saudi Arabia’s probably against Iran producing more oil. Aside from their recent disagreements in the Middle East, it’s threatened by Iran’s rising influence in the region. And unless Iran’s allowed to produce four million barrels per day, we probably won’t see a deal reached by April.

So, crude’s bear market rally should end soon. If I’m right, crude — and stocks — could remain choppy and elevated into April’s OPEC meeting. But when the deal shows signs of breaking down, crude may re-test the US$30 per barrel level sometime in May. If this happens, stocks should plunge with crude.

If you want to know more on this story, check out Resource Speculator. I’m looking at recommending the best oilers to buy on the dips, here.

Regards,

Jason Stevenson,

Resources Analyst, Money Morning


Money Morning is Australia’s most outspoken financial news service. Your Money Morning editorial team are not afraid to tell it like it is. From calling out politicians to taking on the housing industry, our aim is to cut through the hype and BS to help you make sense of the stories that make a difference to your wealth. Whether you agree with us or not, you’ll find our common-sense, thought provoking arguments well worth a read.

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