Is Oil’s Bounce for Real?
Finally, some welcome news for energy investors! After the worst quarter on record for oil, futures are having a monster day in percentage terms as I write on Thursday morning. The Main WTI contract (CL) was, at its height, up around 30% on the day and over 42% above its low at the start of the week.
That’s pretty spectacular, but can it last?
To be honest, when I consider what we have seen over the last month or so and where we are with the Covid-19 pandemic, my gut reaction to that question is to yell no at the top of my voice. However, when I look at the year-to-date chart above and consider what is causing such a massive move, I am not so sure.
There is at least a chance that we have now seen the lows and may even continue to move higher. However, I wouldn’t be in a rush to buy right now.
What the Chart Says
First, let’s deal with the chart aspect.
If this was just a massive one-day bounce such as we have seen on several occasions on the way down, on March 2nd, 10th and 19th, for example, I wouldn’t trust it at all. Intraday volatility like that is not reassuring at all to anyone who understands that volatility can be upward as well as downward and is a symptom of a lack of liquidity. If anything, it is another reason to worry.
This, however, is different.
On Monday, CL hit a low of $19.27 before bouncing to end the day at 20.28, then reversed that pattern on Tuesday, when it moved higher early before dropping back to close slightly lower on the day, at 20.10. That tells me that traders have tried a push lower as a squeeze, then tried a push higher, and neither really worked out.
What that does effectively, is form a support level with multiple touches, and that is a level that has far more chance of holding and proving to be the launch point of a real recovery than the one touch levels off which previous short-lived retracements have bounced.
Trump Announces New Supply Cut Agreement with Saudis and Russians
Even with that, though, unless there was a reason for less pessimism on either the demand or supply side of oil’s pricing equation, any real upward movement was unlikely. Covid-19 continues to spread and efforts to reverse that continue to shut down economies all over the world. Good news on the demand side still looks a long way off. That leaves supply as the only area where traders could see something to be positive about.
We got some of that yesterday as rumors started to circulate that an agreement between Saudi Arabia and Russia to reinstate crude output quotas was possible, and even more on Thursday morning when Donald Trump tweeted then told CNBC that he spoke to President Putin and Mohammed Bin Salman, the Crown Prince of Saudi Arabia, and they had agreed to resume output cuts.
So, why not pile in immediately? I am not making a partisan political point here, but my hesitation here is not because of the message, but because of the messenger.
Will They Happen?
Whatever your political views, it is hard, based on his three years or so history of political life, to place much trust in what Trump says out loud and off the cuff.
In fact, within hours of him breaking the “news”, a spokesperson for Putin said that no conversation had taken place and the Saudis refused to confirm a production cut. They did, however, call for an urgent meeting of the OPEC+ group, which includes Russia.
There is no way to know for sure what all that means, but I have a working theory. The sequence of events suggests to me that there was an agreement, but when Trump blurted it out and tried to take credit for it, the others backed off a bit. Still, the fact that a meeting looks likely indicates that cuts are coming.
That seems to be the market’s interpretation, as CL gave up some of the gains when the denials came but was still trading at around $25, up well over 20% on the day, early in Thursday afternoon’s session.
Strategy
So, what does all this mean for traders and investors, and how should you play it?
First, it means that a wait and see approach is far preferable to rushing in to buy with everything you’ve got.
A new deal to restrict crude supply looks very likely but isn’t certain. The politics of OPEC have always been complicated, and they got even more so when others were added to create the OPEC+ group. That was ably demonstrated a month or so ago, when the agreement to limit production fell apart when it was most needed, as demand cratered. It seems that nobody in this group is averse to doing severe damage to themselves if they think it will do even more to others.
The market reaction to that breakup should have been a chastening experience for all concerned and is providing a lot of motivation here, but we are still dealing with a group of largely undemocratic countries, all of which are used to getting their way. There is still plenty of room for a screw up.
Even with that in mind though, the likelihood of a deal is high enough that buying would be the right move were it not for one thing. The size of the reaction priced in almost all the good news and may even be a bit overdone. Supply cuts will help stem the bleeding, but for a while at least, demand has been obliterated, so the short-term upside is limited.
I would rather wait and buy either crude itself or a few select energy stocks when oil makes its next move.
There is a chance that will be a continuation upwards, but if that is the case it is unlikely to maintain the pace of Thursday’s jump, so you probably won’t miss out on a lot by waiting. More likely, though, is that crude retraces a bit from here and gets close enough to what now looks like a pretty solid support to make for a good entry point.
Even in wild markets, patience is often a virtue!
Cheers,
M
