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Bottom Spotting (Or, yet another way to tell if we’re wrong)

Our story so far: Several weeks ago, we noted that Oil was potentially topping in the $57 - 59 area. Our concern was that a small counter-trend rally in oil might trap investors into thinking the run was over. If Oil resumed its prior trend, the unwary might find themselves trapped.

Since then, events have been unfolding as if according to a script. Even our previous expectations of Oil entering a “Stupid phase” have been rewarded when a competitor projected a possible “super-spike” to $105.

We find this extremely Crude scenario wanting in analytical rigor. Barring an unpredictable external event (i.e., terrorism or an invasion from Mars), we seriously doubt that Oil could reach that level on its own. Why? About halfway there, the high price of energy would grind the global economy to a full halt. If $55 oil is a drag on the economy, then prices some 50% higher - $75 to 80 - would act as a financial parachute. The deadweight economic drag would reduce demand to the point that Oil prices would beat a hasty retreat from those levels.

Regardless, we find it prudent to war game scenarios that disprove our thesis. Not as an act of contrition, but as a way to validate or disprove our expectations. Previously,  we noted 3 ways that could happen:

1) a faster than expected sell off, reaching very oversold conditions;
2) a break out to the upside over March 7 highs on strong volume;
3) a series of improving economic data showing inflation free growth.

A fourth signal would also make our Bearish posture unwarranted: William O’Neil’s Confirmation day.

We find it a reliable way of telling when a sell off has been exhausted and broken. O’Neil noted the significance of days when the Markets “follow-through” with a strong rally (up 1-2% or greater), on better than average volume. This confirmation day ideally shows up in the 4th through 7th day following the first day of higher trading (post-reversal). The big rally last week was on Wednesday, so we are now on confirmation day watch, from Tuesday (4/5) until next Monday (4/11).

Barring a big follow through day, our Bearish expectations remain. Perhaps oil rallies to the high end of our price range ($57 - 59), or even surpasses it slightly. Beyond that, however, we are most doubtful, as Crude is becoming an increasingly crowded trade.

Monday, April 04, 2005 | 06:00 PM | Permalink | Comments (6) | TrackBack (0)
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Comments

I'm with you guys on crude being overbought at $57-$58/bbl.

I heard today that the US Federal Reserve is almost full. Up to now, it was filling at a rate of 250,000 bbl/day. When it is done filling, there is going to be a surplus of 250,000 bbls/day that wasn't there before.

Another thing: this is the time of year when refineries change over from winter heating oil to gasoline. As a result, they are out of production a bit. Expect larger crude inventories in the next inventory report.

Posted by: bear2 | Apr 4, 2005 6:48:32 PM