Crude Oil at Bearish Extremes

In contrast to my last post on gold, indicating that the correction in bullion has further to go, the sentiment picture for crude oil is far more constructive. I now have doubts as to whether my near term $100 oil call will come to pass.

Investor sentiment now very negative
Sentiment surveys on crude oil show that readings are now at bearish extremes, which is contrarian bullish. In addition, the CFTC Commitment of Traders data shows that large speculators, or hedge funds, have sold down their crude oil positions near levels where bottoms are seen. Indeed, COT Timer has flashed a buy signal for crude oil this week.
My estimate of mutual fund positioning is also encouraging for the energy sector. Consensus mutual funds have sold down their energy holdings to a market weight from an overweight position. By contrast, smart funds remain overweight the sector.
Long term bullish on oil
I have stated the case to be long-term bullish on oil before. In addition to those reasons, Barry Ritholtz at Big Picture found a great chart showing the growth path of world GDP and oil demand as another reason to be long-term bullish on crude.

Volatility a function of tight supply?
Commodities have always been volatile. Recently the oil price has been more volatile than usual with the market seeing regular $3-5 daily swings. Kurt Cobb postulated that queueing theory could explain oil's wild price swings. You could also argue that the current tight supply condition is acting like an inventory control model. The shifts in demand and the fact that incremental production can be brought on at much lower pricing, though with a lead time, suggest that the level of minimum inventory is highly variable. The fact that some of the investments are highly levered also adds to the volatility of minimum inventory level.

Buy oil/short gold?
Given these conditions on gold and oil traders could consider buying crude oil and shorting gold. Note that this is a tactical trading call and there are considerable risks involved. Most notably, the chart of the oil to gold ratio below shows that the ratio is already extended in favor of oil.

Comments

[CLH:]

You are right short term. Oil will have a dead cat bounce but this will not cure what ails oil .

By the way no one has made a case that oil has anything to do with gold which is money and only sees the dollar which is headed up and gold down.

Your idea to short gold and go long oil is probably not a loser but also not a winner.

2008 Aug 20 07:45 AM

[jse17:]

Boone Pickens is in total agreement with Mr. Hui. Our Middle Eastern friends realize they are depleting a finite entity and will do all possible to maintain oil’s price.

Of course if oil costs rise appreciably, we can certainly contact the Russians and Hugo for assistance!

2008 Aug 20 08:18 AM

[mangolfer:]

Just found this on AOL. What ever these guys say, do the opposite!!

August 20, 2008
Goldman Sachs (GS): Oil Headed Back Toward $150
Goldman Sachs (GS) says oil will be back at $149 at the end of the year.

The investment bank reiterated its year-end price forecast of $149 a barrel for U.S. crude oil, and said strong fundamentals were a more important factor than a strengthening dollar, according to Reuters.

Douglas A. McIntyre

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Posted at 08:14 AM in Oil & Gas | Permalink

2008 Aug 20 08:23 AM

[Gigem77:]

Oil has held the 112 support and is heading up. Gold is already 40 bucks off the lows set last week. Short one or both and lose money.

2008 Aug 20 09:33 AM

[Keltorttruth:]

Why would you say to do the opposite of what Goldman says? I'm not being critical, I'm asking. Do you have some evidence that when their past reports have come out on crude that it has done the opposite? Off the top of my head, I thought they had been fairly correct.

2008 Aug 20 11:20 AM

[ICouldBeWrong:]

I find this article interesting and is certainly food for thought. Personally I'm not trading heavily at the moment and are restricting myself to light positions only.

Long crude I'm ok with, and I wouldn't be surprised if oil keeps on outperforming gold, (I think this makes sense if we've reached peak oil). But I think there are better shorting opportunities than gold, especially now after the steep fall in gold (1033/770~=733/550). I prefer to short XLF, the equities bear market leader, Historically gold has correlated with commodities, and commodities have correlated with oil. Oil up, will drag gold up.

I'm not sure about using the COT reports, personally I've never been able to reliably profit from them.

2008 Aug 25 01:34 AM

[Fred Voetsch:]

This article should be a lesson for all speculators. I am writing this in February 2009 and oil is at $40 a barrel and we are in a depression, though nobody really wants to call it that yet.

The housing market is still accelerating downward and just about every economic indicator is in freefall yet the speculators who became geniuses in the 80's and 90's have yet to learn their lessons. That is what this era is all about; until these people have been washed from the scene by the economic tsunami washing over us we will not see another bull market.

Feb 07 12:24 PM