Why I'm Bullish on Oil

A concept I often discuss is how the primary trend of a market influences stock prices. If the primary trend is bearish we should expect prices to cascade lower. When indices around the globe crashed to synchronized lows in November 2007, this served as confirmation that the primary trend was bearish.

As the rally from these lows has faded, some indices have broken to new lows (i.e. 40 and Dow Transports) while others have refused to confirm these lows. Despite the terrible economic data and lack of clarity about how companies will navigate uncharted economic waters, the NASDAQ and Wilshire 5000 remain over 12% above the November lows and the S&P 500 is 10% above its November low.

While the possibility remains of a major sell-off driving these markets lower, the large spread some indices enjoy between current stock prices and prior lows raises the possibility of a bullish non-confirmation. If the strong indices can remain above the November lows and rally to a price that surpasses the January peak, the trend will begin turning bullish. At this point, I believe there is an excellent chance such bullish action will occur. If I am correct in assuming that markets will head higher over the coming week and turn the primary trend bullish, the recession could end within six to nine months. As the recession ends and global growth begins accelerating, we should see inflation return and hard assets outperform. Such an expectation is the basis of this week’s technical trade in my newsletter EPIC Insights.

The travails of oil are known to all investors. Last summer, people turned to commodities as they were among the only asset classes working. With press reports decrying the role of speculators driving up the cost of energy products, oil closed above $145 on July 3. Since then, a cooling global economy, ineffective actions by OPEC, and massive margin calls drove the price per barrel to $31.41 on December 22 (a 78% drop in five months). Since the December low, many rallies have failed as the persistent downtrend has quelled each rally.

As illustrated in the chart below that traces the peak in July to current levels, oil has exhibited a classic fan pattern. With a fan, the trend has not fully reversed until the final of three trend lines has been violated. With respect to oil, this would require a move through $65 per barrel.

While risk-averse traders may prefer waiting for such a price move to confirm that it is now safe to reenter the commodity markets, I have seen enough positive attributes to warrant immediate action.

With a strong rally on Friday, oil prices have violated the first of three major downtrends. Further, the shares are trading above the 10-day and 50-day moving averages [MA]. With the 10-day MA turning higher, I expect it to serve as support for a rally that should move toward the two remaining downtrends ($53 and $67). By using the 10-day MA as a stop loss order, a long position in oil offers tremendous upside with minimum downward risk.

For individual investors, the U.S. Oil Fund (USO) offers an excellent option for owning oil. Using oil’s 10-day MA as a stop loss (currently $39.41), I recommend USO as this week’s technical trade.

[click to enlarge]

Comments

[fjpenney:]

Sean:

Based on the historical seasonal pattern of oil prices, an oil ETF would normally be a good buy in mid-February. I am going to wait and see how the market reacts to this week's slew of earnings reports. I thought the markets would be off more than they were today given some of the earnings reported. Perhaps it is a good sign that the markets didn't decline much today.

Jan 26 02:45 PM

[cyclingscholar:]

According to TECHNICAL ANALYSIS OF STOCK TRENDS by Edwards and MaGee, which was written when most of you "worst bear market since the depression" nervous nellies were still gettin' scratched by your daddies, the FAN rule applies to corrections in a bull market; not rallies, in a bear market.

cyclingscholar

Jan 26 03:19 PM

[Perry1961:]

Can economies around the world recover with 30 or $40 oil? I don't think so. Previous recessions required $20 oil to pull out of the slump. It looks like OPEC will do its best to prolong this. Idiots.

Jan 26 03:33 PM

[peterjohnz:]

"oil’s 10-day MA as a stop loss (currently $39.41)" must be a typo.
Do you mean $31.94, which was today's low?

Jan 26 04:25 PM

[the ilster:]

everyone keeps assuming we are going to recover from this recession. I hear no specifics on how that will happen except for Government and monetary stimulis. Good luck this will be a total suckers rally if we get one.

Jan 26 04:48 PM

[peterjohnz:]

I agree with the ilster. We will recover but it could take years.


On Jan 26 04:48 PM the ilster wrote:

> everyone keeps assuming we are going to recover from this recession.
> I hear no specifics on how that will happen except for Government
> and monetary stimulis. Good luck this will be a total suckers rally
> if we get one.

Jan 26 04:57 PM

[blinkmnt:]

Not only years but a economy model change, else the US will enter a maturity stage were growth is scarce and its world role is dimished by other fast growing nations, less civilized, meaning CAOS... the multi-polar world..!!


On Jan 26 04:57 PM peterjohnz wrote:

> I agree with the ilster. We will recover but it could take years.
>

Jan 27 07:47 AM

[romerjt:]

Ali Al-Naimi, the Saudi oil minister and de facto head of the OPEC oil cartel gave 60 Minutes the prices - $2/bbl. to get it out of the ground; $55/bbl balances their budget; $75/ bbl. so the marginal producers of OPEC can make money. That's the price parameter.

From here the pressure on oil prices down; . . . . increased stability in Iraq equals more oil, maybe as much as 3 bbl./day . . . and every time the word hybrid or plug-in is mentioned (like @ all over the Detroit Auto Show) it gets harder to see prices increase.

Take Note - a plug-in driven 12,000 miles w/6000 on the battery, uses 120 gal of gas per yr. compared to 600 gal/yr for a car that gets 20 mpg. That's not just better, its entirely different. That IS energy independence; more than half a trillion dollars not sent out of the country / economy and probably why the Saudis are developing their own fuel efficient auto engine.

We're conditioned to think about this stuff based on the last 8 years when the government had no - zero - interest in saving a drop of oil. All of that has changed. The only people in the world you haven't caught on to the saving energy concept is the our Republican party, part of the reason why they lost.

The only wild card, literally and figuratively is the oil-as-an-asset futures market where it is possible that nutty investor types (47 bbl traded for each bbl used) may stampede the price again. Wasn't the purpose of a futures market to create price stability?

Jan 28 05:40 PM