Why Investors Are Likely Wrong About Oil Right Now

Why Investors Are Likely Wrong About Oil Right Now

When oil prices go extremely low or extremely high, investors are usually way off base in their assessment of it. When oil was near $150, they couldnt see a day when it would go down and the same went for when it got as low as $33 per barrel in late-2008. They simply couldnt see a day when it would ever recover once again.

In fact, I remember being in an oil play around the time it was near those old lows and Id messed up and told one of my friends about it. He made it his mission to come by my desk about every day to tell me how stupid it was for me to be in an oil trade because after all, oil would never recover again. In fact, he said it would continue to head lower.

Again, investors (many times even savvy ones, even) get it wrong at or near extremes in price. Well, Im writing this to you now because weve come off of those extreme levels once again as oil hit $26 per barrel and has been bouncing back.

However, when the bounce back happens, people are still just as negative on it as ever because they always view it as being temporary. All they can see is what has happened rather than what is likely to happen, going forward.

Exclusively getting your future opinion of an asset by what its done in the past is as dumb as driving forward in your car yet only looking in the rearview mirror.

Dont get me wrong. Theres definitely a place for looking at historical pricing. I look at it often. But its only one of many factors when analyzing a commodity, stock, index, etc.

But there are several reasons why Im bullish long-term on oil right now. The first reason, Ive already alluded to. When the negative sentiment is so thick you could cut it with a knife, its paid off long-term to do just the opposite.

Its the investing principle that Warren Buffett quotes often: Be greedy when others are fearful and be fearful when others are greedy.

Now, he doesnt mean to literally be greedy. Hes saying when one emotion is so dominant in the market, its paid to be on the other side of the trade than the masses because the masses generally get it wrong. Its why you cant make your investing decisions by turning on the financial news.

The financial news will tell you what has been and it will correctly display the current sentiment but that doesnt give you any indication about what will happen going forward. Theyre simply reporters, not analysts. So, theyre correctly reporting what has happened and what is happening, but that has no bearing on what will happen going forward.

And youll find that people can always justify their inaccurate view. For instance, right now you could say, Dont you know theres a glut of oil out there and a sluggish economy and a dollar thats been strong? These have all been headwinds to oil.

And thats correct. However, that only explains what has happened and what is happening. But investing is all about judging what will happen in the future and investing accordingly today to take advantage of whats coming. Thats the part many people wont get down pat because they wont choose to think independently. After all, its just easier to turn on the nightly news and let them spoon feed to you the opinion you should have about the way things are (and the assumption therefore is also its the way things will continue to be).

So, besides the uber-negative sentiment on oil out there right now, why else am I bullish long-term on oil?

Lets take a look at the chart below and Ill show you what Im seeing.

When the global economy almost collapsed, oil fell to $33 per barrel and almost no one ever would have thought that it could climb back up to the $75-$114 rangeyet it did!

What do we have today? Weve had an oil price that actually went lower than when it did when the global economy almost collapsed ($26 per barrel) and yet both of those extreme prices in oil proved to be ultimately wrong and short-lived (in the grand scheme of things).

Sentiment is almost always the most pessimistic toward the end of a downtrend and still as negative on the first pullback after the long downtrend (because they dont think the downtrend is over).

Well, thats where were at right now. Oil rallied from $26 per barrel up to over $55 per barrel but then proceeded to pull back to the $45 area. So, the sentiment is still super-negative yet the way people feel about oil is not to be confused with what is likely to happen going forward. So, if youre steered by public opinion, youre always going to be selling when you should be buying and buying when you should be selling. And youre almost doomed to always be buying an overvalued asset and not recognizing and buying an asset when its truly undervalued (due to negative sentiment).

You see, in a perfect world, assets would always be near their true fair value. So why the wild swings over time? One major factor is that markets are driven by people and people are emotional creatures. The emotions of fear and greed drive them. So, when theyre overly fearful, they misprice an asset and it becomes undervalued. And when they become overly greedy they misprice the asset and it becomes overvalued.

Thats why you have to be willing to step in and buy when everyone thinks youre crazy and no one agrees with you and you have to be willing to sell when people think youre an idiot for turning loose of an asset that has risen considerably, yet has gotten overvalued.

Now, with a stock there are many fundamental metrics which allow you to measure whether a stock is undervalued or overvalued. But in a commodity like oil, you do have to lean more heavily to the charts and what they tell you about what is likely to happen going forward.

For instance, historically we can see that $26-$33 has been an inaccurate true value for oil long-term but we can also see that $112 to almost $150 wasnt a truly sustainable long-term fair value either.

The truth is usually somewhere in the middle (like $70-$90 per barrel). Additionally, you can see that the long-term (red) downtrend line has been broken and the price of oil has been climbing overall ever since.

Another indication that the long-term tide has turned from down to upward is the direction of the blue, 50-week moving average. Notice it had been trending lower but not its actually trending higher.

(Note: Notice how the trend direction as noted by the 50-period moving average doesnt change directions all that often and when it does, it tends to remain in that given direction for quite some time.)

The thing about a trend is that the trend turns first and later you feel like the trend has turned. But the fact happens first and the feeling comes quite a bit later on. Its why I never ask myself how I feel about an asset. I simply use measurable tools that have no bias and I form my opinions from there.

For instance, notice in addition to the moving average heading higher, that the RSI and MACD are also strengthening as well. Those are bullish signs also for oil.

And even more recently, theres another thing that oil likely has going in its favor. The direction of the dollar is likely turning lower.

While the dollar and oil do not have a super-strong inverse correlation (like the dollar does with gold), the dollar still has a huge effect on the price of oil long-term, particularly as it concerns oil bottoming periods.

Notice the last couple of times that the dollar broke its green uptrend lines that bottoms were put in on oil and significant rallies emerged in oil.

Well, Im writing this now because it appears that the dollar has broken its uptrend yet again. Well get further confirmation of that once the dollar index falls below 91 and continues to hold below it. If that unfolds, then it will be very supportive of oil continuing higher overall.

In addition to all of this, I expect commodities in general to rise overall because theyre one of the only undervalued pockets of value left out there in the financial markets. And institutional money has to flow somewhere. It cant just go 100% out of stocks and 100% into cash, like you or I could do in our own personal brokerage accounts.

No, theyre paid to be invested and not to sit in cash. Sure, they can have 5-20% in cash, but they cant just sit mostly in cash. Theyre paid by people to be invested.

Therefore, when they come out of an overvalued asset (like many stocks right now in the stock market), they have to find a home somewhere in some other undervalued asset (such as commodities, right now).

As money flows into commodities broadly from gold to agriculture to oil, oil will be a huge beneficiary just as pros see the broad-based trend into commodities in general.

The bottom line: Were still near the lower extremes and the real, fairer value for oil is likely somewhere in the $70-$90 per barrel range.

Keep in mind too that Middle Eastern countries need higher oil prices to meet their budgets, Russia needs higher oil to stay out of a recession and here in the U.S. they need higher oil prices to put oil workers back to work and to reclaim some great paying jobs. So, there are many reasons to be bullish on oil long-term right now even though the masses wont see it.

God bless!

Comments (13)
No. 1-13
Acrosby
Acrosby

well, oil is a commodity and that's what the overall market seems to be ignoring so far. glad you're pointing us in the right direction

shmcc2000
shmcc2000

We're still going to be using oil for quite some time. Yes. Plus, its used in making clothing, household products. not just to power our cars. Agreed.

Evan Loebs
Evan Loebs

Whatever happened to the Pickens Plan?

shmcc2000
shmcc2000

I'm not sure. I know he was promoting a plan that would help bridge the gap between the oil era and the clean energy era. He was proposing natural gas run 18-wheelers and wind farms through a certain stretch of the middle of America that's known for being particularly windy, etc. But this doesn't count oil out for a very long time (and Pickens is still an oil investor).

Russ
Russ

Sean, a huge nugget in your article for investors and that is to be a contrarian investor. Doing the opposite of what most people are doing, will usually pay off handsomely.