It Ain't Over 'Til It's Over - The Oil Bear Market At The Bottom Of The 8th

Includes: USO
by: John Gilluly

The bear market in crude oil is now in its 9th month.

U.S. oil inventories have risen to 444ML barrels, the highest level in 80 years. 69ML barrels (18.4%) were added to inventory in just the last 10 weeks.

The Oil Volatility Index (OVX) has begun dropping from multi-year highs, indicating this bear market may soon be over.

In 2008-2009, it took 3 attempts before the crude oil bottom was finally "in". And prices afterwards continued to be Mr. Toad's Wild Ride. Past as prelude in 2015?

The Gold to Oil Ratio may have called the bottom of this Oil bear market - to the day - as it did in 2009.

Yogi Berra, the all-star player/coach for the New York Yankees and Mets, is well-known for his aphorisms; his most famous being, "It ain't over 'til it's over". He said this of his last-place Mets in September, 1973, just before they swept their entire division down the stretch and went all the way to the 7th game of the World Series.

Another famous quip was, "The future ain't what it used to be", which surely could be said of the many oil drubbings (as much as -10%) that have followed apparent breakouts to the upside in oil. Every time you think this bear market has gone into hibernation, it comes roaring back to claw at investors. So let's take a look at this bear that simply refuses to "go away", and begin with the extreme volatility that has marked his powerful claws.

A simple explanation of volatility is "Less is good. More is bad. Real bad." When volatility rises, commodity and stock prices almost always fall. Here is a chart of 2009's oil volatility and its commensurate effect on price.

(click on all charts to enlarge)

And a similar chart for 2015.

Until this week (March 2-6, 2015) oil's volatility had remained near 6 year highs, despite an $11 rally from January 29th to February 3, 2015 (+25%). Volatility continued to trend higher too - a non-confirmation of the rally or bottom (yet).

As oil's volatility increases, it drives down the price per barrel and creates a continuous drag or weight on the commodity. The next chart is the effect of volatility (OVX) on West Texas Crude (WTIC) through February 3, 2015 (3 month chart, with notes).

Here is the same volatility over a six month span.

It is also easy to see how the rise in the U.S. dollar was complicit in the decimation of oil prices.

But when we look at these charts (below) from 2009, we see that a very different pattern began to present itself a full 2 months before the final bottom was in. Volatility began to recede, and once it fell, it never looked back. This gradual cessation was a sign of things to come; and investors who accumulated positions at this point were well-rewarded when the final trend change occurred.

What followed after that dramatic bottom on February 12, 2009, was truly Mr. Toad's wild ride.

So what of today? Something very hopeful began this week. For the first time in 3 months, volatility suffered a radical breakdown, falling almost 24% in 7 days, down and through the critical support level of 50. And this, while U.S. oil inventories grew a staggering 69ML bbl in the previous 10 weeks.

Does the oil market know something we don't know? When the market does something illogical like this, a wise trader will take notice and look for points of confirmation. The current estimate of lows in the crude market vary from $20-$45/bbl. In layman's language - that's a range between lose-your-shirt and safe from here. In other words, not reliable information.

But if we watch what assets do with themselves, despite commentary to the contrary, then what's happening now is very interesting. The market may be setting itself up for a leg higher in crude oil.

So how to play this possible rise? Buy the United States Oil Fund (NYSEARCA:USO) and hold it until crude oil hits $74/bbl. That is the price of crude most bandied-about as an eventual 2015-16 target. If reached, it would result in a tidy 47% profit in USO (@$28/share).

Lastly, as a postscript to this article, the Gold to Oil ratio highlighted in a previous January article may have called the bottom - to the day - for both the 2009 and 2015 oil bear markets. The stats and dates in these two charts are eerily similar. (See below)

Disclosure: The author is long BBG, CHK. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.