Thursday, February 5, 2015

Oil "possibly at or near" a bottom: Sonders

Gas prices dropped below two dollars in Wittenberg on Friday, January 2, 2015.


So far in 2015, the buzzword on Wall Street is oil. The sudden drop in prices last summer extended through January, before rallying 20% the past 4 days (it’s down 3% again today). “Oil” mentions litter the pages of Q4 earnings reports. Economic forecasts run on about cheap gas prices and the impact on consumers. Everyone wants to know, needs to know, what’s next for the world’s favorite fuel.

But that’s the problem – no one really knows. Charles Schwab Chief Strategist Liz Anne Sonders replied, simply, “I don’t know,” when we asked her if the recent rally in crude means we’ve hit a bottom. She went on to site several reasons for, and against, the argument that a bottom is here (or near).

Rig Counts

Number one in Sonders reasons for why a bottom might be here (or near) is the steep decline we’ve seen in rig counts. “In the past, when we’ve seen the rig count drop by 20-25% in this span of time, you were close to a bottom in oil,” she said. As Yahoo Finance Editor-in-Chief Aaron Task pointed out, a lot of that was wildcatters closing down their rigs.

But as always, the devil is in the details. “The at, or close, [to a bottom] is important, because in a few cases [historically] where you weren’t at the bottom but you were close time-wise, you still had a bit to go percentage-wise.”

Contango

“You recently got into steep contango,” pointed out Sonders. For the un-commodity savvy, contango is when the price of further-dated futures contracts are higher than shorter-dated contracts. For example – contango occurs if the price of oil for March delivery is cheaper than contracts with April delivery.

“A lot of speculators have been loading crude on ships and just kind of hanging it out there until prices [rise], literally,” she said. “These are the types of things that tend to happen at, or near, bottoms in oil.”

Rally

“We’re in bull market territory with the rebound,” mused Sonders. Even though oil prices are, overall, still down some 50% since June, the 20% rally of the last few days has technically put us in bull market territory.

“It does remind me a little bit of the Nasdaq circa 2000, 2001 where you would have these ferocious rallies and people would say, ‘That’s it, the bottom’s in,” and then of course you were heading back into the soup on the way to 2000,” said Task.

Sonders also pointed out that oil bottoms tend to be V-shaped. “When you do find a bottom in oil, unless this is a very different environment, they don’t tend to be either Ls or kind of choppier elongated bottoms,” she said. But that doesn’t mean the Vs are totally balanced – the right side rally may not recover all of the original price.

Production

The biggest argument against an oil bottom comes from production, which is a big “but.”

“Production is still at a record, which I think the people who do attempt to forecast oil price tops or bottoms probably would point to, the fact that production is still at an all-time high as maybe a reason why we haven’t quite hit bottom yet,” Sonders said.

If you’re trying to play the market, Sonders' best advice is to keep your portfolio at market weight. “It’s maybe still too soon to buy, but probably too late to sell,” she said.

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