A Bottom for Oil… But Don’t Buy Yet

The major news this week, if you could call it that, was the US Federal Reserve’s interest rate meeting. But it wasn’t very newsworthy. There were no surprises with the decision to leave rates unchanged.

Nor was it surprising to read the ambiguous spiel in the statement. In case you were unsure — don’t worry — the Fed will raise rates very slowly…

The Committee expects that economic conditions will evolve in a manner that will warrant only gradual increases in the federal funds rate; the federal funds rate is likely to remain, for some time, below levels that are expected to prevail in the longer run. However, the actual path of the federal funds rate will depend on the economic outlook as informed by incoming data.

The Fed used the meeting to ratchet down the amount of interest rate hikes it expects this year. If you remember from the December meeting, the Fed said it expected to raise rates four times during 2016.

Well, the market never believed the hawkish rhetoric. The issue of credibility became an increasing factor in discussions around the Fed.

Now, the Fed only expects two interest rate rises this year, with the next rate hike more than likely to occur at the June meeting. But, apparently, the Fed plans to get serious in 2017.

Based on median projections, in 2017 you’ll see four rate hikes, amounting to 100 basis points, bringing the official interest rate to nearly 2%. That’s despite their economic growth forecasts being slightly lower in 2017 than 2016.

It doesn’t make sense at all — raising rates aggressively while economic growth slows.

It won’t be long before the Fed’s credibility takes another mortal blow. It looks like they will tighten monetary policy into the end of an economic expansion. This will either crash the economy, or make a mockery of their attempts to normalise interest rates.

Given the Fed won’t deliberately attempt to crash the economy, they will instead makes fools of themselves in trying to get interest rates back to normal. They will continually delay their planned rate hikes.

The market’s reaction to the Fed’s blathering was interesting to say the least. Despite already discounting the Fed’s former aggressiveness on the path of interest rate rises, the market responded positively to the more ‘dovish’ tone of the statement.

US stocks rose around 0.5%, but it was the commodity markets that stole the show. Oil jumped more than 5% while gold was up US$30 an ounce, or around 2.5%. Clearly, there is still a lot of bearish positioning in the commodity space, and any hint of easier money is good for this sector.

Given the now very ‘easy’ European Central Bank, a desperate China and increasingly dovish Fed, the conditions for commodities have been good recently.

As always though, it pays to look at a chart to get to full story. If you’re sceptical of charts, don’t be. They are simply an illustration of all the factors that drive a market, stock or commodity. They are a combination of fundamental and emotional factors and, as a result, are very powerful tools when trying to assess the future direction of markets.

Let’s have a look at a chart of West Texas crude oil. This is an important commodity to look at because the market has come to see it as a proxy for global growth and risk appetite. Oil down, market down. Oil up, market up.

Here’s the oil price over the past two years…

Source: StockCharts

Click to enlarge

The recent bounce has been impressive. But in the context of a two year decline, it’s little more than a counter-trend rally. The blue and red lines in the chart show the 50 and 100 day moving averages (MAs) respectively. The direction of the MAs is a good indication of the underlying trend, because they smooth out day-to-day price volatility.

In this case, the 50-day MA is still well below the 100-day MA. So even though the MAs are stabilising, the downward trend is still dominant. You need to respect this. If you look back to 2015, many people thought the price bottomed out in March. The price rallied all the way to near US$65 a barrel.

But the trend never really turned up. It was just a big bear market rally.

Whether the same thing is happening again is impossible to tell. My guess is that oil probably put in a long term bottom in February. But the bounce from the low is too sharp to be sustainable.

It is very rare to see any asset — be it a stock, index or commodity — bounce sharply in a ‘V’ formation after a multi-year decline.

I’d rather see a ‘basing’ period where prices test the bottom a few times. If the lows hold, and buying support comes in, you know that ‘accumulation’ is taking place. That is, longer term investors are accumulating stock. The market is moving from weak hands to strong.

This is what sets the stage for both a sustainable rally, and a new upward trend. The strong hands won’t sell on a minor rally. They are looking to ride the trend much higher. And if they get it right, the fundamentals will eventually vindicate their decision to buy. This will bring more buyers in, pushing prices higher.

I don’t see that oil has established much of a ‘base’. So even though I think this might be the bottom, it’s likely that you’ll see another test of the lows in the months ahead.

If you’re brave, you might want to accumulate energy stocks at this point. Or, if you want to invest with a higher level of probability, you’ll wait to see if the lows hold.

Either way, I think this sector is shaping up as a great buying opportunity. But I’m happy to watch and wait for more evidence at the moment.

After all, the global economy is hardly a picture of strength. We have coordinated monetary stimulus from all the major central banks, and are still only eking out below trend growth.

So the fundamentals for oil don’t look ready to support higher prices just yet.


Greg Canavan,

Editor, Crisis & Opportunity

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Greg Canavan is a Feature Editor at Money Morning and Head of Research at Fat Tail Investment Research.

He likes to promote a seemingly weird investment philosophy based on the old adage that ‘ignorance is bliss’.

That is, investing in the Information Age means you have all the information you need at your fingertips. But how useful is this information? Much of it is noise and serves to confuse, rather than inform, investors.

And, through the process of confirmation bias, you tend to read what you already agree with. As a result, you often only think you know that you know what is going on. But, the fact is, you really don’t know. No one does. The world is far too complex to understand.

When you accept this, your newfound ignorance becomes a formidable investment weapon. That’s because you’re not a slave to your emotions and biases.

Greg puts this philosophy into action as the Editor of Crisis & Opportunity. As the name suggests, Greg sees opportunity in a crisis. To find the opportunities, he uses a process called the ‘Fusion Method’, which combines traditional valuation techniques with charting analysis.

Read correctly, a chart contains all the information you need. It contains no opinions or emotion. Combine that with traditional stock analysis and you have a robust stock-selection strategy.

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