Crude oil futures rallied strongly on Thursday, and are on the move again today—a move that seems surprising to many after the price had fallen by almost 6.5% in the first part of the week, closing at $141.65 per barrel at its low.
Then the market ripped higher on Friday morning, and the bulls showed that they will not be denied, as missile tests have renewed talk of war with Iran.
To learn what might happen next, my colleagues over at Logical Information Machines queried their market database to find out what has happened in the past when the crude oil market has seen a strong rebound of 1.5% more in prices following a three-day decline of 3.5% or more.
They discovered it has happened 79 times in the past 25 years, and crude oil has traded higher in 76% of the cases over the next six trading day by an average of 4.8%.
The average of the 19 declines was -2.7%. Thus the average is 3%, which puts crude oil prices well on their way toward $150 by the middle of next week.
So why was oil acting so strangely earlier in the week, only to turn around now?
The culprit is not just Iran but the U.S. dollar, which trades inversely to oil. That is, when the dollar moves up, oil moves down, almost in lockstep these days.
The dollar has been moving down in fits and starts all year, and crude oil futures have acted almost as the “anti-dollar.”
Earlier in the week, you see, the dollar is actually strengthening a touch, which has put a damper on crude oil futures. And that in turn leaned a hard shoulder on the shares of our oil and gas producers.
The reason the buck was rallying is actually a pretty interesting story…
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The dollar has been rising because the world seemed to have suddenly realized that monetary authorities in Europe are raising interest rates in a deliberate effort to drive the Continent’s economy off a cliff.
Since currencies are a proxy for economies, and currencies are always traded in pairs, you can see why a falling euro has stirred new life into the dollar.
And the revived dollar, in turn, as I just said, has helped to chill the price of oil.
Now it may sound crazy that the European Central Bank wants to kill the European economy, but it makes sense in a weird way.
You see, the European Union is a marriage of convenience for most large European countries except the United Kingdom.
Just to be glib and gloss over a lot of complicated history, the EU was created to help France, Germany, Italy, Belgium and friends compete better against the United States and Asia. The most reluctant of the group was Germany, and so the EU has traditionally leaned a little bit more toward giving Berlin what it wants to keep it happy.
Now if you have any recollection of recent European history, you may recall that the most devastating thing to hit Germany in the last century from an economic point of view was the hyperinflation of the Weimar Republic.
To Germans, inflation is now absolutely anathema. So now that inflation has reared its ugly head around the world, the German leadership at the European Central Bank is doing everything they can to kill it. The ECB believes that the best way to kill inflation is to smash economic growth by raising interest rates. So that is what it is doing.
For awhile, fund managers around the world were buying the euro because higher interest rates are a positive for currencies. But now that it looks like the EU is intent on stunting European economic growth, the tide has turned and fund managers are selling the euro—a path that naturally pushes the dollar higher.
That’s a very long and involved way of explaining why crude oil prices are falling…
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…but at least it provides some context and back story for what’s happening.
You may have noticed that many of the oil and gas stocks I have been recommending all year were hammered at the start of the week, with favorites like Stone Energy (SGY), Quicksilver (KWK) and EOG Resources (EOG) down by as much as 10%.
The reason was that the market was just reacting to short-term news, giving us a new opportunity to buy into the sector.
You can put your finger on 100 different fundamental reasons, but they’re all just rationalizations.
The bottom line is that fund managers get nervous around this time of year and decide to take their profits before heading out on vacation.
As you can see in the chart below, the July stall in Stone Energy that we saw a few days ago happened also at this same time a year ago.
At times like this, I like to turn to the great energy investor David Anderson, at the Palo Alto Investors hedge fund in the Bay Area.
In an email conversation this week, he reminded me, “We are five years into a 20 growth cycle for energy. There are two drivers: population growth and per-capita use. Both are increasing globally, and I challenge anyone to find data to the contrary. Even if we here in the U.S. drop our oil consumption by, say, 2% (which would be hard), the rest of the world can more than make that up with less than a 1% increase in use, which comes from westernization/industrialization of those economies. Meanwhile, natural gas is the fuel of choice in a carbon-constrained world.”
So now with a big rebound yesterday and today we can see that those pullbacks were not the end for oil and gas holdings.
I know it may sound nuts, since they’re all already up so much, but Anderson and I agree that these stocks can all double from here even if oil is at $90 per barrel and natural gas is at $9—neither of which is likely to happen soon, if ever again.
Meanwhile, if oil stays anywhere above $125, these companies are an absolute steal today.
And if you believe, as I do, that crude oil will be at $150 by September and as much as $200 by year end, well, just do the math.
Jon Markman is editor of Trader’s Advantage and a regular contributor to Investors Insights. To get this type of actionable insight from Jon and other InvestorPlace Media experts, visit www.InvestorPlace.com today!