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.