Has Oil Finally Bottomed? By Brad Thomason, CPA
Asset markets go through fairly similar cycles of rise and fall. Notice I did not say “predictable,” as that would imply a level of sameness that goes beyond what I’m getting at.
But I’m comfortable with “similar.” There are common stages, and they seem to apply irrespective of which asset we’re talking about. The reasons driving the price movements in one episode versus another can be quite different: weather in coffee growing regions usually doesn’t have much effect on rental rates in Boston. But once something starts an asset price heading in one direction or another, some similar patterns become evident.
It’s also worth noting that asset markets rise and fall all the time. They just usually do it outside the field of vision of most folks, investors included. A relatively few markets get most of the attention. Ask the typical US investor when the big stock market corrections have been and most can remember 2000 and 2007. Some even recall 1987. But ask that same group when the tin market had rough patches, and most of them will respond with, “there’s a tin market?”
In addition to the stock market, one of the other “visible markets” is oil. It gets talked about on the mainstream news, and we see some evidence of it when we fill up our cars. So that makes it a real thing.
Oil has gone down in the recent past. A lot. You probably knew that. The question that everyone wants to know is, how low can it go? For the time being anyway, we may have the beginnings of an answer.
One of the things that makes a commodity a commodity is that it’s always worth something. We may have trouble determining exactly how much, but at some inherent level we all agree it’s not worthless. We all know that a barrel of oil is useful. So the value can’t be nothing. The action of the market is simply a reflection of our changing views about just what that something is. Because the interaction of human viewpoints is the ultimate determinant of price, which causes the set-up for the similarity I mentioned earlier. Even though the asset in question may change and the circumstances may change, how we work through those changes follows repeating patterns.
In simplest terms, what they told you in Econ 101 holds: if the price of a useful thing gets too low, people will start buying it whether they need it right away or not. When they do, the price stops falling and starts to head the other way.
If we look at some recent developments in the price chart for oil, we see several interesting developments.
During the second week of February the price was back in a sustained decline, and in fact moved to even lower territory than anything we’d seen so far. But on the day it reached its lowest point, the price rebounded by the end of the day, closing more or less where it started. This is a major signal to traders that a down leg is potentially ending. What followed was several days of price recovery.
Prices of course don’t go in straight lines, and when the action started turning negative again 4 or 5 sessions later, we got our next interesting data point. The price fell from the recent trading high, but it stopped well short of heading back down and retesting the previous week’s low again.
Then another interesting thing happened. The market opened gap-up the following morning. This is one of those things that can be real or illusion, and it often takes a number of extra sessions to know which. It may be an indication that longer-term money is getting back into the asset. Or it could just be traders looking for a quick swing. The speed with which the gap closes (they can stay open for weeks or even months, sometimes) is often an indicator of which. This gap closed just a few trading sessions later. Since then, the price has continued to rise.
So has oil finally bottomed? There’s of course no way to know for sure. But if you look at the anatomy of typical price recoveries, you see a lot of the features that have now become part of the recent chart for oil.
In an earlier blog <<hyperlink>>> I pointed out that oil’s fall was a prime indicator that it was something to keep an eye on in the future. History tells us that the biggest moves in most assets come on the backside of declines. Although it is much easier to say than to do, the logical response to this tendency is to dodge as much of the decline as you can, and ride as much of the recovery.
The assessment of the bottom is key to that philosophy, as the bottom is the transition point between the thing you want to avoid, and the thing that you want to participate in. They are hard to hit right on the nose. But most of them actually look pretty similar, sometimes almost as soon as they occur.
Oil has not produced what I consider to be the strongest of all bottom signals (which I guess I should write about in a future blog…), but it has certainly shown signs that it is more interested in going up from here than back down. At least for awhile. Given that certainty is seldom on offer in the investing world anyway, that shift in the odds is noteworthy.