Is Oil “Bull” For Real?

According to Dow Jones Marketwatch, “Oil prices officially charged into a bull market Thursday…” That’s since bottoming on August 2. Here we are less than 2 weeks after the declaration of an “official” bear market in crude, we now have an official bull market. Apparently, major trends move with lightning speed these days.

A gain of 20% or more is “officially” a bull market, regardless of the normal beta of a market or commodity. And who makes it official? Is it by Administrative rule, an Act of Congress, a UN Proclamation? What is the official governing body deciding bull and bear markets? Is it the NBER, which decides (after the fact) when is the US economy in recession? The idea that a 20% rally is a bull market is certainly commonplace in the media, but nobody seems to know which organization made the rule. Oh well. Maybe it’s the official Media Echo Chamber Rule, where once a member of the media is quoted by another member, it’s officially a rule.

Nevertheless, and notwithstanding the thought behind the “rule”, here’s a chart illustrating its application to the crude oil market. 

Phew! That was exhausting.

By this rule, the oil market has seen 4 bull markets and 4 bear markets over the past two years, an average of one “bull” or “bear” market every 3 months. I don’t know about you, but I seem to remember learning that 3 month moves are intermediate swings, not major trends. I remember too that bullish trends were defined by higher intermediate highs after higher intermediate lows.

Apparently, most financial journalists have never learned the fundamental principles of technical analysis. Those bull and bear market “rules” grew out of the observations of Charles Dow and Robert Rhea, which became to be known as the Dow Theory. Ironically, today’s Dow Jones journalists know nothing about those basic principles developed by the great founders of the Dow Jones Averages and The Wall Street Journal. To today’s Dow Jones reporters, technical analysis is impenetrable, or worse, voodoo.

I’ll tell you what is impenetrable voodoo–their echo chamber reporting.

I don’t disagree that oil is probably in a bull market. I don’t track the price of crude directly, but I do track the ETF of oil producers and refiners, the XLE, whose direction usually mirrors the price of oil. The computerized mathematical technical indicators that I use are more sophisticated and sensitive than the rudimentary measures like Dow Theory which were developed in another era. The earliest developments in TA were used mainly as a means to identify trends rather than forecast them. The more modern indicators started to turn bullish shortly after the lows were made in January. They suggested then that the bear market that began in 2014 and persisted through early 2016 had ended.

Crude oil would need to surpass $52 a barrel to be in an old fashioned confirmed bull market. That would render a higher intermediate high after a higher intermediate low, traditional confirmation that the major trend was bullish. In addition it would complete a reverse head and shoulders bottom pattern that began to form in the third quarter of last year. In the ordinary usage of old fashioned technical analysis, the conventional measuring implication of such a breakout would suggest a target of around $75/Bbl for crude oil.

The supply demand fundamentals on Oil have also turned bullish. The US is a microcosm of world oil supply and demand. We have good current data on US supply and demand. The industrial production index for oil and gas extraction released on Wednesday August 17 shows that production (new supply) has been falling since last year. At the same time, the weekly EIA data on gasoline demand which makes up the bulk of crude oil use, shows that demand has been surging since 2014. That’s current through last week.

Looking at the history, US oil production had been falling and demand rising between the early 1990s and 2006. Not coincidentally gasoline consumption peaked along with the peak in the US housing bubble in 2006. During the period leading up to 2006, the retail price of gas tracked right along with increasing demand and decreasing supply.

Then something funny happened. Demand started to fall in 2006 and supply began to increase in 2008 as the fracking revolution got under way. But the price of gas in the US continued to rise into 2008 in spite of increasing supply and falling demand! This was the blowoff phase of the massive bull market in energy prices. Ultimately, in 2009 the price could no longer buck the fundamentals.

With supply rising and demand falling, prices finally fell sharply in 2009. That continued a period of wild price volatility, with another big increase coming in 2011. That price increase also ran counter to the fundamentals, which had become very bearish.

Another price anomaly has developed over the past year. As supply has fallen and demand has increased since mid 2015, the price of oil and gasoline continued to fall. Prices at the pump presently are at their lowest August level since the summer of 2005. If American drivers continue to drive more and production of new supply falls or at least stabilizes, an upside reversal in prices is in order. The price of crude oil has responded accordingly since February. But gas at the pump hasn’t. It’s likely to happen sooner rather than later.

If gas prices do increase in response to the rising input cost of crude oil, that will have an impact on the Fed’s favorite inflation measures, pushing them higher. That should be another nail in the coffin of a Fed September surprise– an interest rate increase.

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