The Difference Between (Oil) Cycles and Doom

The Difference Between (Oil) Cycles and Doom

by | published February 8th, 2013

In early December, I predicted that West Texas Intermediate (WTI) crude would reach $105 a barrel by the end of the first quarter. I also stated that Brent crude would reach $127 a barrel.

At the time, WTI (priced in New York at the NYMEX) was at $85, and Brent (priced in London) stood at $108.

Well, given where we are this morning (WTI north of $96 and Brent pushing $120), my projections may end up on the light side.

With seven weeks to go, both benchmarks will probably surpass the levels suggested.

But something keeps coming up that we've discussed here in the past.

There are still pundits out there trying to frighten investors into thinking the floor is about to collapse on oil prices. Notice that these prognosticators have been unusually quiet of late.

And for good reason.

They are wrong.

Now I have confronted them before and provided some detail on why they are wrong.

True, the ultimate objective for most of them seems to be selling a single solution (you know, buy gold, or move into some selected exchange traded fund, or even move to Costa Rica), while some are even privately shorting the market they hope your concerns will drive down.

I am certainly not suggesting that oil will be moving up consistently from here, or that we will be testing all-time highs in the short term (although that may be shaping up in oil products, especially gasoline).

What I do want you to understand, however, is the major fallacy in their predictions.

And once you learn it, you can do very well as oil prices rise.

Oil Prices are Cyclical, It's that Simple

The doomsday crowd does not understand the nature of aggregate cycles.

Sure, they provide us with pretty graphs and trend lines. Yet they then read them as unidirectional indicators, as simplistic predictors of what is about to happen. Even then, they read them wrong by selecting only certain non representative periods – the ones that “prove” the sky is falling.

Certainly, all advertising from political campaigns to residential burglar alarms has demonstrated that scare tactics work. Throwing a conspiracy theory in and now you're really got a story to sell.

The problem with this approach in the oil market is rather clear. It is not telling you what is actually happening. Nor can it provide a realistic projection of what is to happen.

Look at the solitary premise upon which all of these arguments are predicated. Since they are all based on a simple market demand or available supply volume as the governing factor in determining equaling oil prices, one of two things must happen for them to be correct.

Either we move back into a more or less permanent recession (curtailing demand) or new unconventional sources of crude will permanently provide a glut of supply, either of which driving down prices to $40 a barrel or less.

Neither Theory Is Sustainable

I have spent some time in OEI showing how neither of these approaches holds water. The conclusion to be drawn from this column carries the understanding one step further. And in the process, it also drives home why the underpinning of the doomsday forecast is incorrect.

Charts are thumbnail sketches of fundamentals. They are not, in themselves, forecasts of anything. They also do not reflect actual pricing or market activity. Rather, they provide us with indicators of the cycles through which pricing or activity occurs.

To confuse cycles with result is one of those basic mistakes made by most of me beginning university students. Actually, charting is a heuristic device, a simplified expression of underlying dynamics.

It does not explain what happens and it most assuredly does not provide the reason for anything.

Over the past several weeks, one could have easily designed representations of a breakout in oil prices, a retesting of the $147 a barrel WTI from July of 2008, or an impending constriction in oil supply. For the record, I believe the first is building, the second is possible, and the third virtually a lock in some regions of the global market.

Yet that is not the point here.

As a general representation of market movements, charting is only one of several available tools. As a representation of technical elements, it has a use. But when it is combined with a preordained view of where that market should go, it results in some major misrepresentations.

Oil prices will recede upon occasion and there are a number of reasons from market miscalculations to the need for investors to take profits off the table. Ultimately, it is a series of underlying factors that determine the overall trajectory of oil prices. And these are not always moving in lockstep.

Today, oil prices are rising and a new base appears to be forming north of $100 in New York and $125 in London. These are likely to receive continuing support from an economic recovery finally moving along on both sides of the Atlantic. This will hardly be an even ride.

But Chicken Little is not calling the tune here and the doomsayers will retreat until the next pull back.

At which point, they will be back in force preaching the end and misreading charts all over again.

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  1. Michael Upper
    February 10th, 2013 at 18:26 | #1

    Do you feel the same or very similar reasoning holds for natural gas prices?

    Thanks, Michael Upper

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