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Oil Makes a Statement


Well we seem to have a very interesting situation developing with oil.

On the chart above, I’ve posted the price action for the last 18 months that includes both the run up to $147 and the collapse to $35. I’ve drawn in the retracement levels, and you can see that we have made several attempts to break through the statistically relevant 38.2% level.

Retracements are an interesting phenomenon. The initial attempt and the next couple are generally turned back as well – you’ll remember this discussion from when we looked at the same pattern with the S&P 500 Index earlier this year. But, as the market participants push the price higher and are turned back, IF the price is turned back in a rising tide of higher lows (you can see the upward sloping trend line I’ve drawn in), then eventually the buyers will push the price through the retracement level and make an assault on the next level, the 50% retracement level, or $91 per barrel.

We may not break through the 38.2% level immediately and pull back again to the up-trend line, but it sure looks like the technical picture of investor sentiment is trying to push the price of oil back to $91. The sentiment is being helped by discussions of improving economic fundamentals and increasing demand – all while Mexico is expected to go from an oil exporter to an oil importer in coming months.

This could be one of those times where the technical picture and the fundamental picture are combining to provide us an opportunity to make money in energy and energy stocks.

Our client portfolios are at target weights for energy exposure – we are not over-weight nor are we under-weight. However, if oil can break out above $78, the 38.2 retracement level – we will likely add to energy exposure in anticipation of a move up to $91 at the 50% retracement level.

Investor psychology is a powerful thing – it is what provides for P/E expansion which you might read about in the business papers as one of he things driving stock prices higher. All it really means is that investors are willing to pay more for the same level of earnings than they previously were willing to pay – in anticipation of higher earnings in the future which will be valued at a higher multiple. And, it now appears that this is being applied to oil.

The weak dollar is surely a catalyst as global investors shift from a depreciating paper currency to a hard asset that is a traditional store of value. Oil could be the next beneficiary of the dollar’s decline as gold has been in recent weeks.

Its all worth watching very closely.