Oil May Be Crashing, But Don’t Panic Yet

I am not a big one for sticking to your guns. Consistency that borders on the intransigent may be a good and rare trait in a politician, but there is a reason that there are very few traders who think like that. It is because the ones who did have already gone broke. It is important to remember, though, that in every financial market everything looks most offered at the bottom, and most bid at the top. Oil certainly looks offered right now as we test the lows levels that date back to 2009 and it is hard to find a reason to stick to a bullish outlook, but despite that, this is one time when I am going to stick to my guns. In fact, if you’ll forgive the mixed metaphors, it may be time to double down.

I have been saying for a while now that once the $62 resistance held to the topside in WTI and we started to head downwards, a test of the lows looked almost inevitable. If I am honest, I fully expected it to stop short of the actual low, but that hasn’t been the case. Overnight and early Friday morning, WTI traded below $42, at levels that have not been seen since 2009. Now I know the oil supply situation has changed since then with shale wells going into production, but global demand has also increased.

To logically justify oil at these levels in the long term, from a logical perspective, you have to believe that the global outlook for oil demand is at least close to what it was then. I don’t. I did take a step closer to that belief this week when China announced the somewhat sudden and unexpected devaluation of the Yuan. That hints that the economic situation there may be worse than many had feared. The problem is that there is really no way for us to know. Despite all of the reforms, China is still a command economy with little real transparency, and things can change very rapidly.

Even if the internal economic demand in China is not yet at crisis levels, though, the currency devaluation will have an undesirable effect. China is effectively exporting its own deflationary pressures. The move puts enormous pressure on other developing countries to follow suit in order to remain competitive and a deflationary spiral of devaluation is a possibility. Even so though, a deflationary trend in emerging markets puts us nowhere near the situation in the depths of the recession, when almost all of the world’s economies were collapsing and recording significant negative growth.

There is a slight chance that we could be heading towards the same thing, and I emphasize the word “slight,” but for oil to be priced where it was when that was an actuality makes little sense.

Reading into some other news this week, it seems that we may finally be hitting the point where the price of oil starts to stimulate demand. GM (GM) announced that they will be ramping up production of trucks and large SUVs. That may cause many to slap their head and say “Will they never learn?” but it is a sign of where demand currently is. Fuel efficiency is great, but with gas approaching $2, gas guzzlers are back.

I just have to keep reminding myself that a test of these levels was inevitable. The fact that we are there now, however, doesn’t change the simple fact that, based on historic pricing, oil should not have much lower to go and a bounce back is actually likely. Until a clean and sustained break below these levels, then, continuing to gradually accumulate holdings in large oil companies looks like the best strategy.