Here’s Where It Gets Interesting for Oil Stocks

Sharply falling oil prices Monday night put pressure on US stocks, resulting in slight falls for the Dow Jones and S&P 500. West Texas Intermediate fell 3.8%, to just over US$40 a barrel. Brent crude dropped 3%, to US$42.20 a barrel.

Since peaking back in June, oil prices have now corrected more than 20%. Apparently, this fulfils some people’s definition of a ‘bear market’. This is rubbish. On the contrary, the price action in oil over the next few months could provide you with a very lucrative buying opportunity.

The real bear market in oil took place from mid-2014 — when Brent crude traded at US$115 a barrel — to the start of 2016 when prices bottomed around US$27 a barrel.

From that point, prices rebounded a massive 90% in the space of six months. After such a strong rally, prices were always going to retrace some of those gains. I wrote as much to subscribers of Crisis & Opportunity in early June:

Such a strong move from the low tells me there is a good chance that January was the bottom for the oil price. But…there hasn’t been much of a correction since the rally started. And after an 86% run, I’m wary of recommending energy stocks right now.

Now that the correction is underway, I’m a little more interested in the sector. But I want to see evidence that the correction is over first. As you can see in the chart below, that’s not happening yet.


Source: Optuma
Click to enlarge

But it could be close. What often happens after a strong impulsive rally — like we’ve seen in oil over the first half of the year — is that the following correction gives up around half of those gains.

That means you should look for support around US$39 per barrel for Brent crude. If prices bottom around here, that would be a bullish long term development.

Not that I think the fundamentals for oil are crash hot. There is a lot of supply around, and demand remains weak. According to Bloomberg:

U.S. crude supplies rose by 1.67 million barrels to 521.1 million in the week ended July 22, according to U.S. Energy Information Administration data. Stockpiles reached 543.4 million barrels in the week ended April 29, the highest since 1929. Gasoline inventories expanded for a third week to 241.5 million barrels, the most since April.

But these are the sorts of fundamental conditions that exist at bottoms. Things don’t look bullish at the lows!

So keep an eye on oil and oil related stocks. There might be some good long term opportunities emerging over the next few months.

More immediately, and closer to home, it’s all about interest rates. The RBA meets today to decide whether they should make the price of credit even cheaper. Yesterday I wrote that the RBA should just sit on their hands. What’s another rate cut really going to achieve?

 

Today, the Financial Review’s editorial agrees:

Financial markets are punting that the Reserve Bank of Australia will reluctantly cut its already record low cash rate from 1.75 per cent to 1.5 per cent today. That would be a mistake. The economy may be running a bit below par. But that is not because of any lack of cheap finance: the cash rate has been 2.5 per cent or less for three years now. And the Reserve Bank was relatively upbeat about the economic outlook in its May monetary policy statement. Moreover, there is little prospect that cutting interest rates even further would stimulate any more economic activity – apart from inflating already overblown housing prices. Even looser monetary policy can be counterproductive, as Governor Glenn Stevens suggested in New York at the end of April. It might even dent business and consumer confidence by suggesting the need for extreme policy stimulus.

That’s spot on. The only reason for cutting rates today would be to try and put pressure on the currency. And that’s a battle the RBA shouldn’t even try to engage in. It’s not going to win. There are much bigger forces at play in the global currency wars.

A rate cut today would damage its credibility in a big way. Let’s see how smart (or clueless) our central bankers really are.

One man who understands the futility of relentlessly cutting interest rates is Satyajit Das. He’s one of the keynote speakers at our investment conference in Port Douglas in October.

Writing in the Financial Times today, Das lays bare the trap the central bankers have gotten themselves (and us) into. That is, low interest rates create enormous debt levels, which then require ongoing low interest rates to sustain these high debt levels in a bid to avoid default.

The global economy may now be trapped in a QE-forever cycle. A weak economy forces policymakers to implement expansionary fiscal measures and QE.

If the economy responds, then increased economic activity and the side-effects of QE encourage a withdrawal of the stimulus. Higher interest rates slow the economy and trigger financial crises, setting off a new round of the cycle.

If the economy does not respond or external shocks occur, then there is pressure for additional stimuli, as policymakers seek to maintain control. All the while, debt levels continue to increase, making the position ever more intractable as the Japanese experience illustrates.

This is exactly what has been happening over the past few years. The truth of the matter is that we are caught in a trap. Central bankers know it. They just can’t admit it. So, instead, they maintain the charade…they keep telling us things are getting better and that interest rates are in the process of returning to normal.

Do not believe it, dear reader. We are no closer to interest rate normalisation now than we were in 2010, when Ben Bernanke first raised the issue. You cannot ‘normalise’ interest rates when the global debt-to-GDP ratio is 300%.

As Das points out in his article, at such debt levels, a 2% interest rate means the economy must grow at a nominal rate of 6% to pay the interest bill.

We are now in a situation where a great deal of the productive capacity of the global economy is going towards servicing debt…debt created, I should add, to supposedly improve the productive capacity of the economy!

When you stop listening to the daily blabber of the business media, and you sit back and see things for what they really are, you can see what a farcical situation we are in.

Yet no one in any position of authority wants to tell it like it is. And as I keep saying, there will be no genuine recovery until we get a genuine crisis.

Regards,

Greg Canavan,
Editor, Crisis & Opportunity

Editor’s note: The above article was originally published in Markets and Money.

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Greg Canavan is a Feature Editor at Money Morning and Head of Research at Port Phillip Publishing.

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.

With Greg’s help, you can implement a long-term wealth-building strategy into your financial planning, be better prepared for the financial challenges ahead, and stop making the basic, costly mistakes that most private investors do every time they buy a stock.

To find out more about Greg’s investing style and his financial worldview, take out a free subscription to Money Morning here.

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