Wouldn’t A Crude Oil Top Here Astound Everyone?

The Middle East protests are spreading like a “freedom flu” and they have finally affected an oil producing country, Libya. I’m sure you’ve read and seen the horrific scenes of the military response to the protesters. One effect has been that oil production and shipment has been hampered sending oil prices spiking higher on international markets. Analysts are tripping over themselves to reset their price targets higher: $150, $200, do I hear $300?

I know that there is rampant fear out there right now and the grisly images are difficult to ignore. Yet, we must remember that the market’s job is to provide the maximum pain for the maximum amount of participants. That is to say, it is never as easy as one imagines: trouble in Middle East, ipso facto, buy oil.

My contention is that we are much closer to a top here than a buy opportunity. I realize that I’ve been far too early sounding the alarm for this sector (Energy Sector Update: In The Danger Zone). But considering the evidence, it is difficult to arrive at a different conclusion.

Take for example, the relative distance of the CBOE Oil Index from its own 250 day moving average. Historically, when the oil sector index has overextended itself this much relative to its long term trend, things have not gone well for the bulls.

Right now it is 24% above its 250 simple moving average and 20.5% above its 250 exponential moving average. Either this sector enters into a congestion period to rest after the rally or it corrects.

A recent analysis by Bespoke Investment Group arrives at a similar conclusion. They report that there have only been 5 other times that the S&P Energy sector sub-index has managed to rally 40% over the span of 6 months. In those past instances, in the following month, 3 months and 6 months, the average return has been consistently negative.

The retail crowd is well aware of the momentum available in this sector and has jumped aboard with full fervor. The Rydex Energy sector funds now have almost $400 million in total assets. That is more than quadruple from September 2010, when the rally began 6 months ago. The sector now has more than 25% of all Rydex sector assets. The Rydex Energy ETF has also attracted a huge following with its assets multiplying by 10 over the same period.

The on the ground news is terrible and its effect on oil clear, at least on a superficial level. So how will all this work out to the disadvantage of the price of oil? I have no idea really. Maybe the disruption is Libya is small or it is fully compensated by Saudi Arabia, as they’ve already indicated. Or maybe something entirely unpredictable will happen. I have no idea nor do I pretend to. All I’m able to do is look at the pattern of market prices and distinguish between who is buying and who is selling to arrive at a contrarian picture.

Beyond these short term waves, check out this recent interview with Ray Kurzweil for a truly long term view of peak oil, climate change and our future.

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9 Responses to Wouldn’t A Crude Oil Top Here Astound Everyone?

  1. Tiho says:

    Hopefully you’ll pick the top this time. If not you can try again, forth time…

  2. PEJ says:

    Babak, indeed I believe we should be toping here. I’ve extensively been covering this topping process during the past couple of weeks: http://realitylenses.blogspot.com/2011/02/oil-top-at-hand.html

    Haha Tiho, I just bought some puts on oil, as discussed a few days ago.

  3. Nedly says:

    nice call on that one

  4. Tiho says:

    Haha! Haven’t you learned that picking tops in a bull market is a suckers game?

  5. Babak says:

    News that Ghaddafi may have been shot with oil dropping sharply.

  6. hans says:

    Babak, a very intuitive call…

    The biggest user (USA) is not using…Hence, the rising inventory….

    I would rather be early at the train wreck than late…

  7. mg says:

    TradersNarrative gives his opinion (Usually as objectively as possible, although biases sometimes creep in which is natural). First of, you don’t have to act on it, no one *has* to act on it.

    Tiho, picking tops is not necessarily a sucker’s game – ask Chanos/Einhorn/Paulson/Burry who have all been picking tops successfully for a living. Ask all the people who got out of the tech bull market in time and ask those who did not get out in time whether they should have been looking out for a top. There is a way to try and pick tops while staying in the game at low cost (ask the gentlemen named earlier).

    Anyway, I’m not saying Oil is making a significant top (I have no skin in the game, in this particular case). However, I want to merely point out that you can be successful picking tops as long as you know how to do it. I accept your point about picking tops being a sucker game most of the time also – as my favorite fund manager says, having an opinion is one thing, what matters more is what you do with it.

  8. Tiho says:

    Bull markets in commodities end when supply overwhelms demand, not when price gets too far away from the 250 day moving average. IEA is begging people to listen and is telling them that the world oil supplies are running out, and that it costs too much money to drill for new Oil. The cost for drilling for one barrel of Oil in the industry is now exceeding $70. We are going to have an Energy crisis in the next few years and yet bloggers are picking tops.

    Majority of those guys, like Faber, Rogers, and Einhorn are very bullish on Oil. Paulson is very bullish on the US GDP, which will also suck a lot of Oil. It’s a commodity bull market. Corrections will happen and a correction is currently overdue, that is for sure. I would not buy Oil right now. I try and buy low and sell high. But I would not call “a top” here either. For Energy bears out there, here is some more extreme sentiment data to help you pick tops:

    – Crude Oil daily sentiment index (DSI) hit 97% bulls during the spike this week
    – COT report showed a huge jump in speculative contracts towards 220,000

    Hans, global crude inventory is falling. OECD days of supply are now at very low levels of 55, which is the lowest level since Financial Crisis. Emerging economies now use over 41 million barrels a day and they are growing at a rapid rate. India’s demand is growing at 10% p.a. Chinese at 6.5%. Also to note is that Crude demand has risen globally for five straight month, according to the IEA, towards 89.3 million barrels a day. Who is going to supply all this Oil to the world? Gulf of Mexico, North Sea and Saudi productions are all on a decline. The world has not discovered a major Oil field, known as an “elephant”, in the last 25 years.

    This is not some random data from some random blogger who thinks Crude Oil will fall to $20, this is the International Energy Agency. If you are bullish on the global economy and still think we are in a equity bull market due to economic expansion, than global energy demand will just keep rising. Who will supply this Oil? OPEC? Haha.

    And if you are bearish on the global economy and this we are now overdue for a bear market, than we all know Ben The Brenank will print more money. That is all he ever does. And that will make commodities go ballistic again, including Oil. And finally, if you are ULTRA bearish on everything and think you just need gold, shotgun and a cave, because a war will happen, than all commodities including Crude will spike like crazy Just look at 1979 Middle East crisis when Crude doubles or even World War II.

    The only way Oil price will go down and stay down, is if we find, drill and extract more Oil cheaply.

  9. Tiho says:

    Picking tops in Crude and Energy Sector is not really working for ya! Oil just hit $105 yesterday.

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