The Folly Of Staying Bearish On Oil Due To 'Excess Supply'

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Includes: OIL
by: Steven Saville

Editor's note: Originally published at tsi-blog.com on April 15, 2016.

When the oil price was bottoming at around $26/barrel in February, most fundamentals-oriented oil-market analysts were anticipating additional weakness due to the likelihood of a continuing supply glut. In most cases, they have remained bearish throughout the price recovery from the mid-$20s to the low-$40s due to the same supply-glut belief. Regardless of whether or not a sustainable oil price bottom was put in place in February, this line of reasoning was/is wrong.

The line of reasoning was/is wrong because in the commodity markets the fundamentals always appear to be lousy at major price bottoms. In fact, as far as I can tell, there has never been a major price low in the commodity markets when there did not appear to be excessive supply relative to demand for as far as the eye could see. Similarly, there has never been a major price high in the commodity markets when there did not appear to be either abundant price-boosting demand or inadequate supply, for as far as the eye could see. The markets work this way because at some point during a bearish trend or a bullish trend the supply-demand story underpinning the trend becomes so well known that it is more than fully discounted by the current price.

Was the oil market's bearish supply-demand situation more than fully discounted by the current price when oil was trading in the mid-$20s in February? Quite likely, because a) in real terms oil was near its lowest price of the past 40 years and b) at that point there was hardly anyone who didn't know about the oil glut and who wasn't well-versed in the argument that the glut would persist for years to come.

*I think that the oil price bottomed in February and thought so at the time, as evidenced by comments in TSI reports in mid-February and at the blog a little later. The price action hasn't yet definitively signaled a reversal, but it's possible that an intermediate-term reversal signal will be generated at the end of this week.