October 8, 2004
Whether you traffic in the circles of belligerent contrarian
thought or the mainstream market consciousness, chances are today's
surging crude oil market is among the most popular topics of
financial conversations in your world these days.
The spectacular oil market of late has transcended the usual
market boundaries and captivated the attention of everyone. It
is not only the hardcore commodities
bull crowd that is paying attention these days, as even the
tech-stock-worshipping cult of CNBC seems to be migrating to
an all-oil-all-the-time focus. Such a massive paradigm shift
would have been inconceivable in 1999!
This growing popular fascination (or horror) surrounding the
spiking crude oil prices is easy to understand. In this modern
Information Age world totally dependent on transporting vast
numbers of people and goods around the globe each day, the oil
price really does have a ubiquitous impact. Any time that any
physical thing is moved from one location to another, energy
costs are a factor. And oil utterly dominates today's energy
scene, with rising oil prices adding higher transportation costs
to everything else.
As investors and speculators, the amazing oil action in the past
year or so presents great opportunities as well as great risks.
When markets are moving as rapidly as oil, exhibiting broad volatility
profiles that provide many points to buy low and sell high, fortunes
can be won. At the same time though, the longer a market is strong
and the more people that become aware of it, the riskier it becomes
as entry prices march higher.
Like practically everyone else in the financial realms, I have
been pondering oil a lot in the last year. I have written on
oil indirectly as a key component of the general
commodities bull and also from the perspective of oil's
relationship with gold, but not as a primary topic of discussion.
Thus, this week, I would like to examine the ongoing crude oil
bull market, focusing on its potential to be actively traded
To start, it is important to consider the spectacular oil price
action of recent months in context. Our first chart fleshes out
the trend lines dominating this oil bull and offers many insights
into its strength and potential staying power.
When examining any trend, it
is important to consider the length of time that it has been
in force. The longer a given trend has run, the more powerful
the underlying fundamental forces driving it. And the more powerful
the underlying fundamentals, the less likely the trend will end
prematurely before these driving fundamental forces fully run
their course somewhere out in the future. In oil's case its uptrend
is immensely strong.
The uptrend shown on this chart is very well defined since oil's
interim low near $17 in November 2001. The support line drawn
above is rock solid with its several major intercepts over multiple
years. The parallel top resistance line is not quite as well
defined with oil breaking above it in early 2003 and today. When
an uptrend of this considerable length is combined with oil's
periodic forays into the blue sky over its primary resistance,
it is evident that this oil bull is very powerful and chomping
at the bit to gallop higher.
It is interesting that this particular trend in this chart is
on the verge of going secular. A secular
market is a major long-term bull or bear that runs for at
least three years. Not too long after Americans head to the polls
to choose our next fearless leader, this oil trend will have
officially entered the fabled annals of seculardom. And with
oil's lower support line now running way back near $34 or so,
it is almost inconceivable that oil could fall far enough in
the next six weeks, when this uptrend turns three years old,
to knock it below support.
Of course all you oil speculators who weren't totally distracted
and brainwashed by the NASDAQ bubble remember that $17 crude
in November 2001 certainly was not the beginning of this
oil bull. The secular oil bear which began in 1980 really ended
in December 1998, around $11 per barrel. I remember paying less
than $1 per gallon at the pump for gasoline in late 1998, an
absurdly low price that made gas cheaper than the gallon jugs
of drinking water sold at the same gas stations!
So, from a proper and true reckoning, our current oil bull began
in December 1998, not November 2001. That makes it nearly six
years old today, double the minimum standard to declare
a primary uptrend a secular bull. Therefore there is zero doubt
that oil is in a secular bull today, a mighty primary trend that
will power forward, unstoppable, until the core fundamental supply
and demand imbalances driving it are finally brought into sync
at some undefined point in the future. Betting with a fundamentally-driven
primary trend is one of the wisest and lowest-risk plays in all
Just what are these unstoppable fundamental forces driving this
secular oil bull? On the demand side, it is you and me!
Our whole modern way of life is heavily dependent on oil. We
Americans consume more of it per capita than anyone else on earth.
We are blessed with a big country in which we can freely drive
anywhere for any reason, and many of us live far from our work
and spend an hour or more commuting, burning oil, each day. Everything
physical we buy, all our goods, is also transported to us in
oil-burning vehicles. Oil demand is not going down unless the
whole economic paradigm undergirding modern civilization somehow
The European nations burn a lot of oil too, for the same reasons
as us Americans, but not as much per capita. The US and most
of Europe import vast amounts of oil every day to move people
and goods to where they need to go. And the Americans and Europeans
really don't seem too price sensitive to oil. Whether gasoline
is $1 or $10 a gallon, people still need to get to work, buy
groceries, go out and play, etc. I suspect it would take oil
prices far higher than anything ever witnessed to really get
us to seriously change our oil consumption patterns.
American and European oil consumption has been high for decades,
so the big fundamental wildcard is really the mushrooming industrialization
in Asia, especially the twin behemoths of China and India. With
a combined population approaching 2.4b people or so, these two
countries alone have the potential to eventually consume as much
or more oil than the States and Europe put together. As the Chinese,
Indians, and other Asians in industrializing nations experience
the countless joys and conveniences of living in a modern petroleum-based
civilization, their thirst for oil will only multiply.
This insatiable rising global demand for crude oil, with the
greatest marginal growth coming out of Asia, is one of the powerful
fundamental forces undergirding this secular oil bull. If you
want to bet that global oil demand is going to drop, then you
have to bet that Americans and Europeans will dramatically curtail
their driving and/or the billions of people in Asia will suddenly
cease their vast industrialization campaign. These sure don't
sound like prudent bets to me!
This rising demand simply cannot be met with existing world supplies
of crude oil. Unlike most industries, natural-resource businesses
cannot just boost production at will to meet rising demand. Finding
and extracting oil takes huge amounts of capital and lots of
time. And since the 1950s much of the planet has already been
scoured for oil, reducing the probabilities that large future
deposits will be found without some great leap forward in extraction
And while large new supplies are seldom, if ever, being discovered
these days, existing reserves are drying up. In the last year
several major global oil players actually had to revise their
oil reserve estimates downwards. And if the biggest and
best companies, with the brightest minds and unlimited capital,
are having trouble growing their reserves then new oil reachable
by current technology is just not out there.
World production also seems to be nearing its Hubbert
Peak, its point of maximum production. The brilliant geologist
Dr. Marion King Hubbert defined this theory in the 1950s, which
has proven to be uncannily accurate in the last half century.
He stated that with any finite resource, like an oilfield, production
starts at zero, it then rises to a peak which can never be surpassed,
and then it declines until the resource is depleted. This simple,
yet powerful, logic also applies to all the existing oilfields
collectively, the world as a whole.
Most existing major oilfields now producing on the planet, including
many in the Middle East, are either past or near their Hubbert
Curve Peak. They have been pumping for decades and it is getting
harder and harder to extract oil. Production at individual wells
within many of these fields has already started declining. Eventually
it will cost so much to wring oil out of these tired old fields
that they will become uneconomical and be abandoned. Any given
oilfield taps a finite pool of the black stuff that can
eventually be depleted after enough is extracted.
Thus our current secular oil bull is being driven by relentlessly
rising oil demand worldwide coupled with global oil supplies
that, while not yet shrinking, simply cannot be grown fast enough
to keep up with demand. In any long-term situation where free-market
demand exceeds free-market supply, the only possible market solution
is for a rise in price. As oil gets scarcer relative to those
who want to buy it, its price is bid up so the oil is effectively
allocated to those who value it the most. These ironclad supply
and demand laws can never be broken over the long-term.
When the secular technical uptrend of oil is viewed in light
of its immensely bullish supply-and-demand fundamentals, odds
are this bull market has years to run yet. Oil prices have to
eventually meander high enough, for long enough, to retard global
consumption to bring supply and demand back into line. Today's
$50ish oil, far below the all-time real highs above $90
a barrel in 2004 dollars back in 1980, is probably nowhere
close to being high enough to radically alter ingrained global
As the chart above makes crystal clear though, just because a
primary trend is bullish does not mean that there won't be periodic
pullbacks. Both oil investors and speculators want to buy oil-related
plays low, during corrections. Investors will then hold for many
years while speculators will sell at the periodic oil peaks.
has abundantly demonstrated in recent years, periodic pullbacks
are healthy and par for the course in a secular bull.
The flowing and ebbing nature of this oil bull is readily apparent.
The percentage numbers on the horizontal axis above show oil's
annual gains, year-to-date in 2004's case. Oil has been alternating
massive up years with flat or down years. Like all secular bull
markets, it has advanced two steps before retreating one. This
typical behavior is normal and expected and provides outstanding
trading opportunities for speculators.
In fact, today's sharp oil spike looks remarkably like two of
the previous greatest oil trading opportunities in the last few
years. There are three major uplegs numbered above, along with
their subsequent pullbacks. If you compare rallies 1, 2, and
3 visually, it is apparent that their steep upslopes were rather
similar. In all three cases crude oil advanced sharply, usually
surging to fresh new bull-to-date highs. But in the first two
cases, oil soon retreated in a pullback as general sentiment
waxed too euphoric near the interim tops. Will we see a similar
healthy pullback soon in the breathtaking rally 3 today?
To analyze the possibilities of such a correction, we prepared
a new crude oil graph based on the principles of technical Relativity
I discussed last week. Relativity compares a price to its 200-day
moving average. Bull markets tend to advance and diverge from
their 200dmas before retreating and converging, the typical two-steps-forward-one-step-back
bull-market profile. Per this theory, the best time to go long
oil-related investments or speculations is when oil trades near
its 200dma, when Relative Oil, or rOil, is low. Conversely speculators
probably want to be short or at least neutral when rOil gets
Our final chart graphs this rOil construct, oil divided by its
200dma, on the left axis. Oil and its key moving averages and
Bollinger Bands are graphed on the right. This reveals some intriguing
trading zones of interest not apparent in the conventional chart
Since 2002, which gives us
an ideal slice of time of nearly three years in which to consider
Relative Oil ranges, rOil has been amazingly consistent in reversing
soon after oil trades more than 25% above its 200dma. Twice in
2002, once in 2003, and twice so far this year, oil has witnessed
sharp pullbacks not long after rOil stretches above 1.25 or so.
This suggests that investors and speculators do not have high
odds of success if they throw long oil when it is already trading
so far above its 200dma.
On the low side, marked by the green zone and numbers, rOil is
not as consistent in carving major interim bottoms. Oil has bounced
higher when rOil was anywhere between 0.84 and 1.04, really a
broad range. Nevertheless, this relative comparison does show
consistency in that oil was always an optimum tactical buy only
when it was near or under its 200dma, and never when it was far
If we apply the core Relativity precepts I described last
week to crude oil, a model for actively trading this secular
bull market in oil emerges. Both investors and speculators want
to go long oil-related vehicles when rOil is low and speculators
want to sell and/or throw short when rOil gets too high. In order
to define an actual trading range of interest, we need to consider
two to three years of data, shown above, and define relativity
zones with multiple intercepts.
The top side, the short or sell zone, is amazingly well-defined
in crude oil's case. Out of the hundreds of Relativity charts
I have built and analyzed, this one really strikes me as extraordinarily
consistent. In the past few years oil never retreated significantly
when it was less than 25% above its 200dma, but once it exceeded
this 25% threshold it pulled back soon after, almost without
fail. So we are currently defining an rOil level of greater than
1.25, which has no less than 5 historical intercepts, as our
short zone. This is shaded in red above.
The green buy zone on the bottom is not as clear, but going long
oil-related plays when rOil is less than 0.95 or so seems a happy
medium based on the data. This 0.95 line has multiple intercepts
in 2003, not to mention a near intercept in 2002. In addition,
it more or less splits the recent relative bottoming range of
crude running from 0.84 to 1.04. Thus, this chart suggests investors
and speculators want to be long crude for another major upleg
whenever it trades around 95% or so of its 200dma.
This Relativity perspective on crude helps us define a range
of interest of when crude is relatively undervalued technically,
the time to buy, or relatively overvalued technically,
the time to sell. We ought to consider going long when crude
is at 95% of its primary 200dma support, and going neutral or
outright shorting when crude trades more than 125% above its
And please remember that Relativity is more of an analog probability
range than a strict binary buy or sell signal. As long as oil's
secular bull remains intact, the higher up that rOil is stretched
in a major upleg the greater the probability that a correction
is imminent. Conversely the lower that rOil is pummeled in a
correction, the greater the probability that a major oil upleg
is just over the horizon. Probabilities, not absolutes, govern
This relative trading model, while simple, would have been quite
profitable in recent years. And if oil's secular bull market
in oil continues, as the fundamentals virtually assure, then
this trading model will probably be useful and profitable going
forward as well. Rather than just guessing when crude
is low enough to buy or high enough to sell, the hard Relative
Oil numbers provide an empirically precise way to quantify this
And we certainly must not overlook the message of rOil today.
With oil stretched more than 33% above its 200dma, the greatest
divergence witnessed in years, oil looks extremely overbought
technically at the moment. Remember, short-term pullbacks are
normal and healthy in all bull markets! Oil has been running
very strong for about a year now and positive sentiment is waxing
quite extreme. Markets flow and ebb and oil seems to be about
due for a temporary countertrend ebbing to bleed off these speculative
Thus, I expect an oil correction is due sooner or later here.
If you want to go long oil-related speculations, now is
not the time to pull the trigger. A normal pullback would drag
oil back down near its 200dma, around $39 today. While the technical
pullback will probably happen regardless of news, I suspect some
news will be found to "justify" the pullback.
One intriguing contender for this "justifying" news
is the possibility that Washington will release Strategic Petroleum
Reserve oil in the weeks ahead to attempt to lower oil prices
ahead of the US presidential elections. Regardless of the reasons
ascribed after the fact though, oil just looks plain short-term
overbought and due for one of its periodic bull-market corrections.
No excuse is necessary, though the media will certainly find
If you are interested in monitoring this fascinating ongoing
oil bull, and in trading it, we are now tracking and analyzing
Relative Oil in our acclaimed monthly Zeal
Intelligence newsletter for our subscribers. We are also
hard at work looking at various leveraged oil-stock contenders
for potential recommendation and purchase next time oil retreats
and triggers an rOil buy signal. As gold has proved abundantly,
periodic retreats in secular bulls offer stellar buying opportunities.
Please join us
With global oil demand relentlessly rising while global oil supplies
look flat to declining as far as the eye can see, odds are this
secular oil bull is nowhere close to giving up its ghost yet.
Nevertheless, even the most powerful of long-term bulls have
periodic corrections to bleed off short-term sentiment imbalances.
The Relative Oil indicator suggests that just such a pullback
is probably due soon here in crude oil.
Since these periodic short-term pullbacks often mark the greatest
buying opportunities available in long-term bull markets, investors
and speculators should really watch rOil closely in the weeks
ahead, especially if this probable technical retreat does indeed
October 8, 2004
Adam Hamilton, CPA
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