Sharply falling oil prices overnight put pressure on US stocks, resulting in slight falls for the Dow Jones and S&P 500. West Texas Intermediate fell 3.8%, to just over US$40 a barrel. Brent crude dropped 3%, to US$42.20 a barrel.
Since peaking back in June, oil prices have now corrected more than 20%. Apparently, this fulfils some people’s definition of a ‘bear market’. This is rubbish. On the contrary, the price action in oil over the next few months could provide you with a very lucrative buying opportunity.
The real bear market in oil took place from mid-2014 — when Brent crude traded at US$115 a barrel — to the start of 2016 when prices bottomed around US$27 a barrel.
From that point, prices rebounded a massive 90% in the space of six months. After such a strong rally, prices were always going to retrace some of those gains. I wrote as much to subscribers of Crisis & Opportunity in early June:
‘Such a strong move from the low tells me there is a good chance that January was the bottom for the oil price. But…there hasn’t been much of a correction since the rally started. And after an 86% run, I’m wary of recommending energy stocks right now.’
Now that the correction is underway, I’m a little more interested in the sector. But I want to see evidence that the correction is over first. As you can see in the chart below, that’s not happening yet.
[Click to enlarge]
But it could be close. What often happens after a strong impulsive rally — like we’ve seen in oil over the first half of the year — is that the following correction gives up around half of those gains.
That means you should look for support around US$39 per barrel for Brent crude. If prices bottom around here, that would be a bullish long term development.
Not that I think the fundamentals for oil are crash hot. There is a lot of supply around, and demand remains weak. According to Bloomberg:
‘U.S. crude supplies rose by 1.67 million barrels to 521.1 million in the week ended July 22, according to U.S. Energy Information Administration data. Stockpiles reached 543.4 million barrels in the week ended April 29, the highest since 1929. Gasoline inventories expanded for a third week to 241.5 million barrels, the most since April.’
But these are the sorts of fundamental conditions that exist at bottoms. Things don’t look bullish at the lows!
So keep an eye on oil and oil related stocks. There might be some good long term opportunities emerging over the next few months.
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