Saturday, July 26, 2008

Haiku and More on Oil (July 26, 2008)

We start today with a pithy haiku submitted by longtime contributor Jed H. which perfectly captures the core of the bailout of mortgage lenders:

Profits are Private
But Losses belong to ALL
Our New FED Slogan

Thank you, Jed. That sums it up perfectly. Let's not forget that all those executives at "quasi-public" Fannie Mae and Freddie Mac were paying themselves salaries and options in the millions, and that they gave away millions in contributions to politicos of every stripe.

Now all we can do is make sure we vote against every member of Congress who voted for this historic violation of public trust. Vote for the Green Party candidate, or the Libertarian, or the Democratic or Republican candidate--anyone running against the incumbent. There is so little we can do as individuals but throwing out the incumbents is one message which always resonates with politicos. Yes, I know it won't do much, but it's a start.

Let's look deeper into oil's sudden drop. First, here is an excellent analysis by Sir Charts A Lot (Gary Dorsch) via longtime contributor U. Doran on the many causes of oil's sharp decline: What’s behind the Slide in Oil and Commodities?

Note that demand from China continues rising sharply, supporting my view that a crummy 300,000 barrel/day reduction in U.S. demand is being more than offset by rising demand in other countries--including the oil exporters themselves.

Next, two readers offered interesting commentaries on yesterday's entry, Is Oil Set to Crash? Two Views (July 25, 2008).

First up, correspondent Bruce C. provided some technical analysis commentary:

Charles, FWIW, I agree with Ranier H. about oil. One potential confirmation of an imminent decline in the price of oil is the large head-and-shoulders (H&S) or broadening cyclical top formation for the XOI (Amex oil index), with the so-called neckline in the range of 1295 to 1320s-30s; the H&S target implies XOI ~1000 at a minimum (40% decline from the cyclical high for the XOI) and as low as the 500s-600s by '10 (60-65% post-bubble crash). (The test of the daily-close resistance at 1310-11 "might" have been the top for the current rally.)

Thank you, Bruce, for the informed analysis.
Next, longtime contributor Harun I. offered these comments:

The argument (in the July 25th entry) is interesting but I find no evidence of this argument:

"When someone comes up with a hypothetical oil price number then all I have to do is plug in the Gold/Oil ratio presently at about 7-8 to one and you will come up with what the gold price will be at $1000/ brl oil price. I make this about $7000-$8000 Gold price."

The ratio entered the band of 7-8:1 several times with Gold and Oil at different prices. Gold does not have to go to 8000 dollars/ounce in order for Oil to reach 1000 dollars/bbl. I do not assume and there is nothing that I know of that is sacrosanct about any particular ratio. For all we know the ratio might breakout to the downside and slip to 1:1.

I agree at the current ratio Crude Oil is very expensive. And there is a price point at which all societies will have to change habits whether voluntarily or by force. I know that, barring some chance discovery of new technology, we are decades behind the curve in developing alternative energy sources. Hope is not sound economic and/or energy policy.

Furthermore with all currencies losing purchasing power against gold we can't be too sure that some tipping point may not be breached that sets off a negative spiral of some sort, i.e., a deflationary collapse of currencies causing a hyper-inflationary spiral in prices.

I respect and use EW (Elliott Wave) but I also respect what I don't know. We are at an inflection point on a scale never seen before. The global economy is facing utter collapse. I prefer not to hang my hat on what I think cannot happen; I will simply follow the trend.

Once a trader understand the statistics of his methodology (his edge) he need not spend much time fretting over it. It is the low probability high impact event that he or she must guard against.

Thank you, Harun, for reminding us nothing is sacrosanct in technical analysis. With that in mind, I now offer up some analysis of two charts: crude oil, courtesy of Harun, and a chart of Anadarko Petroleum (APC).

Please go to to view the charts.

Note: I recently entered a long position (calls) in APC. Please read the "Huge Giant Big Fat Disclosure" below before proceeding.

As Harun has noted before, the decline in the Large Trader Index was diverging from the price rise.
Nonetheless, it is interesting to note that APC has declined to support/resistance it first established back in October 2007, when oil was a meager $80/barrel. Is an oil company now worth what it was at $80/barrel, even though oil is still 53% higher, at $123? If you believe oil is heading down to $80/brl or less, then the answer is yes.

But if you suspect the 30% decline in APC and other oil companies is due more to speculation receding than any actual change in supply and demand, then you might be looking for technical evidence the down move is overdone.

Let's start the analysis by noting the potential double top. Both tops and bottoms tend to be re-tested, hence the power of double tops and bottoms to indicate "the real top" and "the real bottom."

But as I also note, there was a clear double top formation earlier this year--one supported by a declining MACD. It doesn't get much better than this, yet nonetheless that turned out not to be "the real top" but merely a way station on the long-term uptrend. Thus we have to take calls of douible tops and head-and-shoulders formations with a big grain of salt. Long-term trends march ever higher and calling the definitive top or bottom isn't that easy.

Next, let's note the many extremes in the APC chart: extreme low in MACD, extremes in DMI and ADX, and the extreme plunge below the standard long-term support line of the 200-day moving average.

This looks like the chart of a financial institution heading for bankruptcy, not a highly profitable oil company. Without getting too fancy, it seems to me that a 30% decline in a matter of weeks in an oil company can only be justified by a belief that oil is heading for a near-complete price collapse, i.e. a 50% drop from $146 to $73.

With the U.S. consumption of oil mattering less and less (that is, representing a diminishing slice of the total global demand pie) and hundreds of millions of new consumers willing to pony up $2/liter (roughly $8-9/gallon) for their motorscooters and other transportation, then a modest reduction in U.S. demand (300K to 500K barrels/day) is the equivalent of a mosquito on an elephant.

As I have said and will continue to say: most Americans have no options but to buy gasoline and diesel at whatever the pump price may be. Not everyone has the cash or credit to go buy a new high-mileage vehicle, and not many Americans can turn to a train or subway who haven't already been riding public transportation for years.

Even worse, the tracks and infrastructure of mass transit are already maxed out.

I don't see oil dropping to $80/brl, but I could be wrong.

Thank you, John G. ($33.33), for your "long-playing" and extremely generous second donation to this site.

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