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Where Is Oil Going?

I need some perspective. That’s why I have posted the chart of oil above. Why oil? All other commodities will key off of oil since it is the largest and most liquid commodity – even bigger than corn. Given oil’s dominance over our daily life and our geopolitical dangers, it is the big kahuna that we should watch. As oil goes, so goes the other commodity areas, and as long as oil remains in a bull market so will the other commodities.

This is the chart of oil over the last couple of years. As you can see, we are clearly in a correction – NOT an end of a bull market as many pundits have been saying. In fact, this is acting much like a classic 50% fibonacci retracement.

If you are not familiar with the concept of fibonacci retracements, here is the definition from Investopedia:

A term used in technical analysis that refers to the likelihood that a financial asset’s price will retrace a large portion of an original move and find support or resistance at the key Fibonacci levels before it continues in the original direction. These levels are created by drawing a trendline between two extreme points and then dividing the vertical distance by the key Fibonacci ratios of 23.6%, 38.2%, 50%, 61.8% and 100%.

If you take the low price for oil from 2007 ($50.82 per barrel) and the high price for 2008 ($148.50), 50% of the distance between the two is $99.66. At this time, the best resistance level for oil seems to be $99.66 or roughly the other psychological round number level of $100 per barrel.

If you are wondering where you may have heard about fibonacci numbers before, you probably like reading pulp fiction mysteries, because Dan Brown discussed them at length in his popular book The Da Vinci Code. Long before he popularized them in a relegous context in his fiction, they have been used in investing methodologies for decades.

Leonardo Fibonacci was an Italian mathematician born in the 12th century. He is known to have discovered the “Fibonacci numbers,” which are a sequence of numbers where each successive number is the sum of the two previous numbers: e.g. 1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144, etc.

These numbers possess a number of interrelationships, such as the fact that any given number is approximately 1.618 times the preceding number.

Interpretation of the Fibonacci numbers in technical analysis anticipates changes in trends as prices tend to be near lines created by the Fibonacci studies. Even though you don’t see 50 in the list above, historically in analysis, 50% is considered one of the retracement levels as it is also psychologically significant.

It seems odd that human behavior can be tied to such things, but the current selloff is a combination of an emotional knee jerk reaction to a slowing world economy – the US is using less oil now, but world-wide demand has been flat (someone, likely China – in spite of what you might hear on the news of their slowing economy…if you can call 9.1% GDP growth slow – is buyng up the excess) and a (temporarily) strong dollar.

We remain in a long-term bull market. This is just a correction, albeit a painful one, but one that will run its course.

We are in the process of establishing a new trading range for oil. Last year, the high for oil was $70 per barrel, and we thought that was horrible. Now, as we search for a bottom, around $100 and everyone believes this is cheap and will fix our inflation problems (more on inflation in an upcoming post – the nationalization of our mortgage system with the rescue of Fannie Mae and Freddie Mac is one of the most inflationary events ever to happen in our country). It is all psychology, and that is where fibonnaci numbers have the unique ability to predict support levels and turning points as sentiment has a pattern of turning on or about the fibbonoci retracement levels.

Is it certain to happen and $99.66 will be the bottom? Of course not, but we are definitely in search for a new trading range. If $50.82 to $148.50 holds as the current range, then the important thing to remember is that we potentially could see $100 to $180 as the new trading range. Higher highs and higher lows is a key characteristic of a bull market.

Oil is in a bull market, correction not withstanding.

Mark