Overbought Oil Doesn't Mean Excessive Commodity Speculation

As oil prices topped $130 and later $135 there was a cacophony of calls from market commentators that the parabolic rise in crude signaled a top in commodity prices and that this is a commodity bubble that would end badly soon.

Oil and Energy stocks overbought

The chart below shows the log price graph of crude oil futures. Prices moved to the top of the rising channel line, from which it has corrected in the past. So a pullback in oil prices in the next month or two would not be a surprise.

The relative return of Energy stocks tells a similar story. The chart below shows the returns of the Energy Select SPDR (XLE) compared to the S&P 500. The XLE moved to the top of the relative trendline against the S&P 500 and appears to be overbought. I would expect a near-term pullback but the relative uptrend would remain intact.

No sign of excessive speculation in resource stocks longer term

 

At the top of every mania, the junk starts to fly. Stupid deals get done. People start talking at parties about how they made a killing in this mining junior or that penny stock. Even here in Vancouver, one of the resource penny stock capitals of the world, there is no sign of that speculation.

The chart below shows the relative returns of the small cap speculative TSX Venture Index compared to the large cap S&P/TSX Index. Small caps have been underperforming large caps since the end of 2006. This is excessive speculation???

No sign of excessive speculation in gold stocks

If we were to look at the pure gold stocks, it appears that we are still early in the move. The chart below shows the relative returns of the equal weighted CBOE Gold Index [GOX], which gives bigger weight to smaller gold stocks, compared to the capitalization weighted PHLX Gold & Silver Index [XAU], which is more large cap oriented. After drastically underperforming the large cap gold stocks, small cap golds only caught up in mid-2006 and it wasn’t until October 2007 that they definitively began to outperform the bigger stocks.

Putting my technician’s hat on, this is a classic cup and handle formation. The breakout in October 2007 would yield a relative return target of roughly 70-80% outperformance of the GOX against the XAU. This suggests that small cap golds have much further to go against their large cap senior brethrens – indicating that this bull move in gold (and commodities) is nowhere close to being over.

Comments

[sbenard:]

Coincidence does not equal causality!

2008 May 27 05:30 PM

[redbaron:]

Good article, IMHO. While not a technician, I also have been watching for signs of the excessive speculation and energy stocks being overbought, as some are 'reporting'. Oil itself may be somewhat overbought, currently, but when one looks at energy stocks, the chart increase seems very gradual, with rational pull-backs from time to time. IMHO, this is not a run-away-bull market.........at least, not yet. If anything, energy stocks are still behind the underlying commodity of oil and natural gas, and need to do some catching up. But then, that is how I see the market, and I am long energy stocks.

2008 May 27 06:32 PM

[GMiki1:]

I'm only in resources these days and have made money year to year. The gold and energy juniors have yet to take off, but they will. Where is the excess in supply? As T. Boone Pickens said (after changing his mind--LOL) we're pumping 85 million barrels a day and demand is 87 million. What is in excess? Gold? Silver? Tungston? Uranium? Lead? Tin? Iron? Rare earth minerals? Moly? Minerals used in agriculture? None of these are in overabundance.

One problem has been that when China began to supply some of these metals, mining shut down in the West. Now China has imposed limits and tarrifs on export of some of these and we will have or already have a short supply of many of the above.

We're in competition for oil, coal and nat gas.

A gold and copper junior I own shares in--Kalimantan Gold (a Canadian company with holdings in Kalimantan, the Rim of Fire) got a pop a week or so ago when the company accounced having contracts that allows it to explore for coal.

The next few years will be frightening to many--me, too--but a great deal will be revealed as to where money is being/will be made. Not in the homebuilders or the banks.

2008 May 27 07:22 PM

[Mosh:]

Of course oil is a speculation! It is very naïve to think that it’s not. Besides, technical analysis do not work when things irrational and probably a bubble.
This bubble has more room to grow but fundamentals do not justify this increase in price. Sorry!

2008 May 27 08:09 PM

[zenalgorithm:]

Oil bull logic: oil has gone up 700% since 2002. Because it has gone up exponentially since 2002 - it must continue with its exponential rise, even if demand drops. It just has to...

www.hussmanfunds.com/w...

2008 May 27 10:07 PM

[MarkNotMoses:]

Oil does not follow charts ... So please, no TA on this.

2008 May 27 11:08 PM