Is Oil a Bubble? Part One

Includes: AAL, DBA, DBC, F, JJN, OIL, USO
by: Jordan Kahn

Oil is now front and center on everyone's radar. Last night, CNBC ran a special tonight about oil, and had a banner running across their ticker titled "America's Oil Crisis." Congress is looking for scapegoats to blame for high oil prices, and is hauling in oil executives to testify, and propsing stupid ideas like a windfall profits tax.

Funny, look at the first chart below of wheat (and the chart for corn looks identical). Looks like wheat and corn have had parabolic moves higher, but I haven't heard any talk of windfall profit taxes on the farmers. Rather, Congress is trying to pass further subsidies for the farmers, who are arguably in the best position of any industry in the country.

The next two charts show the extreme, straight up moves in other commodities. I have included lead and nickel, but there are several that fit the bill. What I am highlighting is that these parabolic moves higher are never sustainable. And when they eventually run out of steam, they usually succumb to large corrections.

Given what we have seen in many of the other commodities, take a look at the chart below for oil. Look similar? If I showed you the charts for all of the other commodities, a logical conclusion would be that the trajectory of the upward moves was unsustainable, and susceptible to a sharp pullback.

However, for oil, for some reason, people think that the recent high prices are a sure signal that $150 and then $200 are right around the corner. Now I want to be the first to say that I have no idea how high oil will go. To be honest, I am surprised it ever reached $135.

Unlike stocks, which can shoot to the moon, high oil is self-defeating. As prices skyrocket, it slows economic activity and can bring some forms of transportation to a halt (just look at the news from AMR Corporation (NASDAQ:AMR) that it is cancelling flights, and Ford (NYSE:F) is curtailing production on some of its gas guzzling vehicles). That, in and of itself, would cause a correction in the price of oil (as demand trails off).

The chart below is from the good folks at Bespoke. It shows the relationship of the current oil bubble to the last 2 big bubbles in tech stocks and then the housing market. This week, the rise in oil eclipsed the mammoth rise in tech stocks in the late 90s. Pretty incredible, huh?

And we know what the end result of those two bubbles were, right? They both ended very badly, especially for folks who got sucked in anywhere near the top. Which brings me to the million dollar question: where is the top?

No one knows for sure where the top is, and those that tell you they do are simply lying. If you had bailed on tech stocks in 1998, you missed quite a move higher still. If you sold your house in 2004, you left a lot of money on the table. So my hunch is that I want to remain long oil/energy names, although I do not want to chase the recent move higher.

That said, when this bubble bursts, most people won't believe it and will continue to buy on the way down. But history tells us that we should look for those signals as a reason to lock in profits for good, and then simply move to the sidelines.

[In Part 2, I will delve into who is really to blame for high oil prices (hint: it's not the oil companies).]