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 couldn’t 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 couldn’t 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 I’d 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, I’m writing this to you now because we’ve 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 it’s done in the past is as dumb as driving forward in your car yet only looking in the rearview mirror.
Don’t get me wrong. There’s definitely a place for looking at historical pricing. I look at it often. But it’s only one of many factors when analyzing a commodity, stock, index, etc.
But there are several reasons why I’m bullish long-term on oil right now. The first reason, I’ve already alluded to. When the negative sentiment is so thick you could cut it with a knife, it’s paid off long-term to do just the opposite.
It’s the investing principle that Warren Buffett quotes often: Be greedy when others are fearful and be fearful when others are greedy.
Now, he doesn’t mean to literally be greedy. He’s saying when one emotion is so dominant in the market, it’s paid to be on the other side of the trade than the masses because the masses generally get it wrong. It’s why you can’t 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 doesn’t give you any indication about what will happen going forward. They’re simply reporters, not analysts. So, they’re correctly reporting what “has happened” and what “is happening”, but that has no bearing on what “will happen” going forward.
And you’ll find that people can always justify their inaccurate view. For instance, right now you could say, “Don’t you know there’s a glut of oil out there and a sluggish economy and a dollar that’s been strong? These have all been headwinds to oil.”
And that’s 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 what’s coming. That’s the part many people won’t get down pat because they won’t choose to think independently. After all, it’s 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 it’s 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?
Let’s take a look at the chart below and I’ll show you what I’m 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 range…yet it did!
What do we have today? We’ve 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 don’t think the downtrend is over).
Well, that’s where we’re 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 you’re steered by public opinion, you’re always going to be selling when you should be buying and buying when you should be selling. And you’re 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 they’re overly fearful, they misprice an asset and it becomes undervalued. And when they become overly greedy they misprice the asset and it becomes overvalued.
That’s why you have to be willing to step in and buy when everyone thinks you’re crazy and no one agrees with you and you have to be willing to sell when people think you’re 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 wasn’t 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 doesn’t 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. It’s 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, there’s 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, I’m writing this now because it appears that the dollar has broken its uptrend yet again. We’ll 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 they’re one of the only undervalued pockets of value left out there in the financial markets. And institutional money has to flow somewhere. It can’t just go 100% out of stocks and 100% into cash, like you or I could do in our own personal brokerage accounts.
No, they’re paid to be invested and not to sit in cash. Sure, they can have 5-20% in cash, but they can’t just sit mostly in cash. They’re 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: We’re 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 won’t see it.