The Significance of Oil's Drop Under $60

| About: The United (USO)

Oil has dropped under $60 this morning, to reach 6 month lows. Prices have dropped more than 23% since hitting a record $78.40 in mid-July. At the same time, stocks have closed in on their May highs.

Why has oil dropped so precipitously over the past 2 months? AP notes that:

The high prices in July and August were largely fueled by concern over the possibility that Iran could disrupt oil supply if sanctions were imposed or if the monthlong conflict between Lebanon and Israel escalated. Fears of hurricane damage to U.S. Gulf Coast refineries also drove the market higher this summer but the storms so far have blown past the coast.

Here is a short list of the most common current explanations circulating in the mainstream media:

1. More Supply coming online;
2. Reduction of global terror threat;
3. Cooling of hostilities between Israel and Lebanon
4. Seasonally weak demand, as Hurricaine season ends;
5. Iran cooling inflammatory rhetoric

I find these some of the mainstream explanations unsatisfying. At the risk of creating a strawman (only to knock it down), let me put forth my top 5 list:

1. Fast money rotating out of commodities and into tech;
2. Cooling economy consuming less energy;
3. No major supply disruption from weather or Middle East;
4. Psychology peaked earlier in year (see BusinessWeek Cover Story);
5. Stretched consumer shifts behavior;
6. And lastly, the Weak US Dollar (Crude is priced in greenbacks)

The biggest mis-statement on the mainstream list/energy discussion is the perplexing meme that somehow terror concerns have been alleviated. I find that rather astonishing, given that the leaders of two of the larger Oil suppliers were in NY at the UN last week talking trash about the Unied States of America.

The eventual confrontation with Iran -- last I checked, they had not given up their nuclear ambitions -- is still looming on the horizon.

On top of that bit of psycho-drama, we learned this weekend that US Spy Agencies Say Iraq War Worsens Terrorism Threat.

So the new idea that somehow the terror threat or the Middle East turmoil has improved fails to resonate with me.

All these explanations remain squishy, however. When in doubt, we go to the charts:

Crude Oil, 6 Month Chart
click for larger chart

Crude Oil, 3 Year Chart
click for larger chart

Major Support for Crude is at $58, minor support is at $55 and $49.

Oil is in the midst of a major correction, and by the traditional measure of 20%, can be defined as in a Bear market. The mainstream explanations are greatly over-simplified.

Why is this important? Understanding why energy prices have dropped can help you avoid positioning your portfolio on unrealistic assumptions.