This is a piece I wrote two years ago. Some of the details are dated but the points are still quite relevant. I hope you enjoy it.
From the archives 12/27/2010
This post was originally going to be about oil and it will appear to be about oil, but I will get to my point eventually. I spent much time over the past two weeks researching oil as I had been hearing much bearish sentiment on the matter. There have been many write-ups on oil in recent months but I have not seen a recent, objective post. What I did see fascinated me. One trader's highlighting of seasonality in OIL in January; another colleague's account of abandoned rigs in Oklahoma; and yet another's first hand thoughts from someone who works in the industry and knows it well.
As I delved further, other colleagues sent me articles on the subject. One said that our reserves were so high that oil naturally had to come down; another said that the state of the economy would bring the price of oil down because of our lack of jobs and housing troubles; yet another said that the price of oil must go up which will then account for more joblessness and housing troubles; finally, another said that while there is plenty of oil in the ground, the cost of extracting it is going up and therefore would push the price of oil higher.
Many of these accounts contradict each other.
Which ones are true ?
The true oil bears were naturally shorting it two months ago as the price has soared upward from mid $70’s to it’s current price over $90 not unlike the stubborn bears who have been shorting the overall market since September invariably getting slapped in the face and defiant of the price action. Others say that the time to short will be January because seasonality dictates so but does it ? As it turns out, if you look at say the last 4 years, yes, oil does drop in January, but when you look at historical prices over a longer term, 27 years to be exact, I find that oil is up in January 51.85% of the time with an average return of $1.59 and down 48.15% of the time. Sorry seasonality traders, I don’t think the seasonality play works here.
What about the idea that rigs are being abandoned in Oklahoma. Are they ? According to Baker Hughes, rig count is actually up in Oklahoma. Of course these are more likely natural gas rigs but I questioned, are we abandoning rigs to build new ones ? Wouldn’t this drive costs and thereby price higher ? Not necessarily, as it turns out, some basins are more expensive nat gas shale plays to operate in and in this case, the rigs are more likely being moved to less costly basins. When the price of nat gas goes up, these basins can come back into use. On the other hand, areas that are more oil based are doing very well at the moment.
Then there is the argument regarding housing and unemployment, suggesting that oil will go up and also suggesting that it will go down, depending on who is doing the arguing, but I have a really difficult time believing that these are not improving as many of the perma bears intone. Everywhere around me, people are getting jobs, not the least of which was thehusband recently and housing is clearly making strides in the right direction.
Still there is the argument that we have tons of oil in reserves so it should go down ; then again, once we get through that oil, the oil in the ground will cost more to extract, so oil should go up.
As I look at the broader market, I hear many say that January will be a huge correction. There are the perma-bears of course, who are whining incessantly that it hasn’t already. There is the idea that that 2009 correlated with 2003, and 2010 correlated with 2004, so it is reasonable to consider that 2011 could correlate with 2005, though some traders are too smart to consider in absolutes. Certainly, we could use a healthy correction and so we hope for a reasonable one and likely we will get it, but will it hurt enough to incite fear ?
By now you are wondering what my point is, and I refer you to my title. Jack be nimble. My point is that as traders we must be nimble. Elasticity is key to banking coin because we can’t predict the market or the price of oil, no matter how good we are at research and analysis. We must wait and see. Price action will be our tell. As such, my intention is to reduce my short term holds extensively by week’s end on strength so that I can be ready for a correction or a buying opportunity in January.
BTW – the answer to which argument is true ? All of them.
And in case it is somehow not clear, I am bullish going into 2011.