PORTFOLIO POINT: With the oil price being supported in the mid US$90 range, now could be a good time to profit as the US fiscal cliff looms.
Welcome to the inaugural Carr’s Call column. This will be a regular fortnightly feature, much less thematic in nature, where I revisit old calls, make news ones or just generally flesh out some observations about the market.
This week oil is at the front of my mind. Regular readers may remember my call to buy crude back in my June 8 missive Why oil is primed for a growth spurt. WTI was at US$84 then, and hit a recent peak of US$99 – a tidy profit if you were lucky enough to take it then. Otherwise at US$92, profit to date is just about 10%, which still isn’t bad for a few months’ work. Now all the analysis made in that note is still valid, so I still stand by it and will make no changes today.
But the game has certainly changed. The elephant in the room is of course the growing political disquiet about higher oil prices. Quite frankly I think I underestimated the degree to which governments were/are prepared to intervene.
Recent official commentary certainly caught me off guard, as did that rapid price fall we saw a week or so ago. Recall crude inexplicably dropped about 7% over two or three sessions. The price action is still under investigation, such was its rapidity and apparent arbitrariness.
Fat finger errors or computer glitches have been blamed, but the jawboning efforts of the US and Saudis weren’t irrelevant. And they were noted by traders.
It’s not that I was unaware of political intervention in the oil market – it’s certainly not the first time this has been done. But the difficulty, and where I was wrong, was in determining where the cap is/was.
Back in March, WTI was comfortably up around the US$110 mark before we saw official intervention. That is, the coordinated commentary we saw from the US, UK and France about releasing oil from the strategic reserves. The Saudis then followed with similar rhetoric. Prices were too high, they warned, and they wanted to bring them down - and would do so by lifting production if necessary. I thought this would be a safe resistance level.
Indeed even just looking at a simple technical resistance level, crude should have at least pushed through US$100, so maybe US$105 should have been regarded as a key level. Instead, and this time around, the cap looks to be around US$100, and this in fact has been stated by the Saudis as their target.
The trick for investors is reconciling the overwhelming fundamental and market factors that support crude prices with the clear, or rather the desirable cap, that governments wish to put in place.
The first point to note, with that in mind, is that the target of US$100 can only ever be maintained temporarily. It can only ever be a key resistance level rather than a firm cap. To see this, consider that the Strategic Petroleum Reserve only carries about 696 billion barrels, or 36 days’, worth of supply. Indeed crude stocks for the OECD in total only amount to just over 30 days. As you can see, the threat to release oil from the reserves is little more than idle, especially given the high probability of hostilities with Iran.
But the threat, credible or not, does move the market as we witnessed and I don’t think that the US$100 level will be broken easily. We would need to see some significant upside support. Central banks printing money obviously doesn’t cut it, but an approach to US$100 accompanied by say, a much stronger than expected US or Chinese GDP report might just do it. Or Spain actually requesting a bailout.
On the downside, and referring back to the chart, you can see there are three key support levels around US$92, US$90 and US$87 – and it doesn’t take much to hit them. Reasonably we could break either way from here then – easily back toward US$87-US$88, but just as easily toward US$99. Having said that, I think there is a higher probability of a larger move to the downside than the upside. That is, a crash through through US$87 and a move over US$100.
Certainly you’d need something pretty serious to spark that. There have only been two recent moves to US$80 or below and both were driven by outright panic. Back in early October 2011 it was double-dip fears in the US in conjunction with ongoing European fears. Similarly, in up to late June 2012 it was fears over a Grexit (Greek exit from the euro) and a flare-up in concerns over Spain.
Concerns obviously still linger but no one is talking a US double-dip now, and all Spain needs do to avert crisis is request a bailout. They can then access the dual canons of the European Central Bank and the European Stability Mechanism. But we do have the fiscal cliff theatrics at year end – and that would certainly be enough to see crude crash through that $87 support.
Weighing it up, I don’t think crude will retest that June low in the near term. So if we do break through to US$87-US$88, I’d buy that dip accepting that the smack-down could come at year end. But I’d certainly be booking profits well before US$99.
In the meantime, and from US$92, we’re faced with upside/downside of 5%-6% but the chance of a major breakthrough of key support/resistance is skewed to the downside (with the looming fiscal cliff).
Taking everything into consideration, I’d take profits now – a bird in the hand is worth two in the bush as they say.
If you want to range-trade in the lead-up to the fiscal cliff, buy those dips at around US$88 if the news flow permits (stay clear if the dip is due to fiscal cliff concerns). Then, make sure you get out well before US$98. Low to mid US$90s should do it for the retail investor, I think.