What’s Next for Crude Oil ?

>
"The commodity looks like it has legs, which is trader talk for its
going higher. While I do not make a habit of forecasting commodity
prices, $110, and then $125 are our next two targets.

I got your core inflation right here . . ."

>

That was our March 3rd quote on energy prices.

As Bloomberg reported this morning, Crude was $125; As I write this, CNBC is flashing that Crude is over $126 a barrel.

We have been Bullish on Oil and energy stocks for a long time. Our first recommendation of Crude Oil was back in 2003, when the price broke out over $32 per barrel. I picked Energy as my favorite sector for the Business Week forecasts for 2004 — something that more than a few people ridiculed at the time.

In 2004, we observed our target of Oil = $50 a Barrel was hit. I also explained why at $40-50 there was no “terror” premium (comments picked up by WSJ, Barrons, and Slate).

Early on, we recognized that it was Chinese Oil Demand underlying the increase in cost. We also looked at why Refining Capacity was a problem.  We have examined Global Crude Oil Demand & Gasoline, we looked at Oil: Inflation adjusted.

We looked at whether Oil Jitters Gotten Overblown?. That answer was no. We also looked at the question:  Do Higher Oil Prices Lead to Recessions? Turns out the answer is yes.  Large Hedge Funds who had been ignoring our bullish energy advice did so at their own peril.

So where does that leave us in 2008?

Well, we have political considerations with the US presidential elections, upcoming Summer Olympics in China, an ongoing war or 3 in the Middle East, and of course, a weak dollar (which is now in a counter-trend rally).

Let me offer one last way to think about Energy: Its relative strength versus precious metals. 

As the dollar has strengthened, precious metals have gone south. Yet Crude oil has continued upwards, implying that this is more than a mere currency story.

Dennis Gartman writes:

"All things being equal, if one were to hear that crude would be $2/barrel higher and then were asked how much stronger gold would be, one would answer, swiftly and with confidence, "Oh, at least $5-$10/ounce." Wrong!! Gold’s down $6/oz, sending the gold/crude ratio to new lows for the past several years. At the current levels, it now takes 7.06 barrels of crude to "buy" one ounce of gold. 15;1 is rather more "normal."

Have a look at this ratio in a 3 year chart:

Wtic_gold

graph via Stockcharts

I’ll see if I can find produce a longer term chart of the ratio above — it might be revealing.

~~~

Its funny, but I got a lot of grief over an $86 forecast several
years ago — but $125 was pretty easily accepted.  That implies a major
change in psychology is taking place.

More on this in the coming weeks . . .

 

>

Sources:
The Gartman Letter
Dennis Gartman,
Thursday, May 8, 2008
http://thegartmanletter.com/

Crude Oil Rises to Record Near $125 a Barrel on Supply Concern 
Grant Smith and Christian Schmollinger
Bloomberg, May 9, 2008
http://www.bloomberg.com/apps/news?pid=20601087&sid=auqhuZnpEFFE&

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What's been said:

Discussions found on the web:
  1. Owner Earnings commented on May 9

    Barry, I’ve noticed that when you get really excited about things, and start posting about them in almost real time, they usually go the other way.

    Most recently I remember in March when you said something like “if we finish down today then it will be time to pile on the shorts.” The market promptyly rallied.

    ~~~

    BR: I have been posting about Oil in real time for 5 years. If you bet against that call, you lost money.

    As to the March comment, I am not sure what you mean. I posed an If/Then statement. The “If” did not happen — so the “Then” portion does not apply.

    i.e., If a rains today, I will take an umbrella. (No rain, no umbrella)

  2. Steve Barry commented on May 9

    For those who follow my random musings, this one can maybe make you money. Oil is likely to hit a number soon that will cause a non-linear equity market event. Look closely at the volume on QQQQ for confirmation. During the entire bounce off the March lows, an astounding 35 trading days, QQQQ volume only once beat its 100 day MA and barely that one time. It looks like the market is now euphoric and starting to roll-over. If this is accompanied by the volume pickup I expect, watch out below for stocks.

  3. Peter commented on May 9

    One of the talking heads from the oil industry was on Bloomberg yesterday mentioned that the spare capacity in the world amounts to around 2% so any slowdown affects the price.

    Once you consider the attacks in Nigeria, the cross border raids by the Turkish into Northern Iraq, the strikes in the North sea and the approaching Hurricane season in the Gulf it isn’t hard to see that a small drop in production can easily squeeze the total supply in the world market.

    Of course, that is ignoring refining capacity which is also stretched and finally declining production in Saudi Arabia, Russia, North Sea, Mexico etc.

    Oh, and the oft used arguement about the current high level of the SPR is pretty poor – the drop in demand in the US that has led to an increase in the SPR is more than compensated by the increase in demand from China/India so global net oil demand is still increasing.

    The weirdest thing to understand is how there are so many people who don’t understand the fundamentals of the oil price increase and blame it solely on speculation. The majority could find hundreds of reasons why the house price boom would continue on forever a few years back, but can’t seem to fathom the current commodity price boom.

    Finally, if anyone really wants to deny that oil prices will remain high then answer this question. Is it really in the interest for any of the OPEC countries to sell oil for less? In some cases oil is the only industry they have and given it is a finite industry they will want to get the highest possible return. So far, the importers have complained about the oil price, but haven’t yet cut their demand significantly. Until they do, why should the exporters ask for less for their finite product?

  4. gallatin commented on May 9

    The Gold-Oil ratio seems to lend credence to GATA’s claims of recent gold market intervention by central banks.

  5. Steve Barry commented on May 9

    For those who sid there were no 30 Million dollar apartments in NYC, here are 10 from $36-75M

  6. William commented on May 9

    As a side note, I wonder if the prospect of consumers “coming into some money” – getting a few extra coins in their pocket from rebate checks – is a bullish indicator for oil – spurring on the eager traders. Does that mean the recent oil cost increases will totally consume the rebate bonanza? Will every cent the US gov’t pumps into the economy from this point on be consumed in burning fuel? Isn’t it obvious Oil price more or less feeds on liquidity, so is there really any surprise here?

  7. wally commented on May 9

    I think this one must be hitting Barry in the back pocket or something. Maybe he doesn’t think he is keeping up with the price of gas? In other words, he has no inflation expectations, only the expectation that his life is getting rearranged.
    It is.

  8. Ross commented on May 9

    What will be extremely funny is when crude backs off 15% from where ever it peaks and the pundits proclaim ‘whew, we knew it was a bubble. The consumer is going to be so relieved’. Goldilocks LIVES!

  9. VennData commented on May 9

    Oil is NOT $125-plus a barrel.

    That price includes shipping, handling storage, brokerage fees, profits for the drillers, profits for the national oil agency at the country of origin.

    If you strip those out, the core price of oil is actually much, much less.

    ~~~

    BR: I really do not get your point.

    Its in the name: Crude Oil for future delivery. All those extras have always been part of the price, back when Oil was $10, or when its $150.

    Perhaps you would prefer we start reporting “Core” oil prices . . . ?

  10. Andrew commented on May 9

    What is going to happen when Congress passes the bill (now being considered) that will essentially eliminate electronic trading of oil?

  11. stuart commented on May 9

    Gold is a messenger, can’t control the illness, shoot the messenger. via London gold pool. Gartman is right about one thing though. Compared to oil bullion is cheap, bullion stocks are cheaper. Peak oil means higher oil, means higher bullion.

  12. cinefoz commented on May 9

    Sorry, but I don’t buy the theory that supply and demand for the commodity is supporting the price of oil. I suspect at least 30% is due to speculators passing paper back and forth in an unholy alliance that nobody except the consumer wants to spoil. It will take an exogenous event to pop the bubble. Without one, the feedback loop will raise prices to $150 within a couple of months.

    Look at the price of copper. It is dipping and might be at an inflection point. If it continues to drop, it will spoil the theory proffered by useful idiots and thieves that oil price increases of several percent a month are appropriate. Dropping copper is also a leading indicator for a stock market fall, providing it is accompanied by a strengthening yen. The movement has been too little to make a firm prediction, but both have moved enough to maintain interest. Money also appears to be moving into the 10 year bond.

    Right now, speculators and buyers are playing chicken with natural gas. Natural gas is typically stockpiled in the summer when prices are lower. Big money is playing the natural gas buyers by trying to force summer purchases at winter prices. Allowing speculators to win will bring in government regulators next year so that the price explosion can be investigated.

    A WSJ story about the FTC investigating the commodity markets was good news. I suspect Obama will follow through on this. When speculator thieves steal from me, I expect them to be raped in reciprocal fashion using sharp edged foreign objects, with lots of vig taken off the top.

    My guess is that the market will finally react to high commodity prices and low profits and even lower expectations by dropping to around the January lows within the next few weeks. This will be a buying opportunity, but will also be a quick turn event. The market will enthusiastically bubble up to a little higher than recent highs. Then, if commodity prices are still raping the rest of the world, the markets will fall to well below the March lows. This last fall might be the exogenous event that pops the bubble for a while.

  13. Ben commented on May 9

    Barry,

    What is your perspective on gold?

  14. cinefoz commented on May 9

    BTW, I believe the proper term for oil and other commodity pricing at this time is a ‘Minsky Event’. At this stage of the ponzi scheme, ‘investors’ depend on rising prices to pay for the loans taken out to make the ‘investments’ in the first place. When an exogenous event makes borrowing or price increases unlikely or impossible, the house of cards collapses. Didn’t something like this just happen?

    If there is enough capital available to support commodity speculation and price feedback loops, then I suspect it is OK for the Fed to start removing some of the credit supplied to prevent market lockups.

  15. DownSouth commented on May 9

    ☻☻”What will be extremely funny is when crude backs off 15% from where ever it peaks and the pundits proclaim ‘whew, we knew it was a bubble. The consumer is going to be so relieved’. Goldilocks LIVES!”
    –Posted by: Ross | May 9, 2008 8:40:25 AM

    “The laboratory worker’s imagination may frame a hundred notions and by experiment settle on one. The lay imagination retains its hundred and utters them, letting them take their chance in the people’s minds. The plausible, the picturesque are taken as truths, influence conduct, and generate fears.”–Jacques Barzun, “From Dawn to Decadence”

  16. Roman commented on May 9

    Can someone explain to me something. We have higher oil inventories then we did at this time last year and yet our oil is twice more expensive. In the last couple weeks, we have seen a rally/counter-rally in the dollar. The trade report just came out showing the trade defecit shrinking and the world economy stalling.

    How do the fundamentals support $126 oil??

    I can’t help it but blame it on speculation. It makes no sense to me.

  17. Loren Steffy commented on May 9

    BizLinks and Open Comments | 5.9.08

    Legislation by Democrats takes aim at oil prices — actually, they’re shooting first and aiming later. Worker shortage looms large for energy industry Economists: No Oil, Food Bubble ($) — fundamental trends are to blame for higher prices. What…

  18. DonKei commented on May 9

    Oil has very inelastic demand. It takes time to adjust habits and economic situations to account for price increases.

    But adjustment will happen. Toyota just posted its worst results in North America in some time for placing a huge bet on huge Tundras (have you seen the size of these things?) that people are no longer buying in droves.

    Once adjustment occurs–give it eighteen months at these prices–look out below. Oil could revisit its lows of the eighties, when it crashed from about $80/barrel at the beginning of the decade to $10 or so (nominal)by mid-decade.

    Please w/ the “things are different this time” bullshit. Humans are ever and always the same, including the hubris that accompanies every age in its thinking that things are really different this time.

    Tight money and increased efficiency (yielding reduced demand) destroyed oil prices in the eighties. Expect more of the same this time. It’s just a matter of when, not if.

  19. Steve Barry commented on May 9

    How do the fundamentals support $126 oil??
    _______________________________________
    How did the fundamentals support the Nasdaq bubble? The housing bubble? You must consider the dollar in this case though. A dollar approaching zero supports oil approaching infinity.

  20. Mark E Hoffer commented on May 9

    BR,

    nice track record on those Oil calls, with those links, you continue to set the mark of excellence..

    as an aside, seeing as GM isn’t using it, and they could use the fundz, maybe you could pick up their TM: “the mark of excellence” and put it where it would, more, rightly rest..

  21. steve commented on May 9

    >>>Please w/ the “things are different this time” bullshit. Humans are ever and always the same, including the hubris that accompanies every age in its thinking that things are really different this time.

    Correction. Same hardware, different software.

    in other words… people are insane, they just find new ways to be insane.

    Sometimes things are different. Like every day. Especially when some dude became the “destroyer of worlds. Do you want sugar or cream in your coffee?

  22. Ken H. commented on May 9

    Barry,

    Good calls in oil but even a simple super model like me knew gold and oil were the next speculation bubble a few years ago. I think gold was 480 and oil 60ish? I never look at quiting ahead as quiting. Anyone claiming fundamentals is full of shit and has no way of proving that. Because there are none. Even the dollar weakness is bullshit as there is absolutely no relationhip here recently. I bet you could show a linear relationship to the rise in oil since,..oh,..the middle of March. Ah yes, the investment banks can borrow from the Fed. From 104 to 126 in six weeks. If you all want to ignore the elephants in the room, be my guest. Many did in both the last two bubbles and didn’t get a chair when the music stopped.

    Honestly, I love it. Good for our country long term. I can just see the oil barrons shitting their pants. Their biggest consumer has started to seriously take up alternatives and consumption is plummeting. Builders blamed the speculators and I suppose the oil industry will too.

  23. DonKei commented on May 9

    “especially when some dude became the destroyer of worlds…”

    Okay, I’ll bite, what the hell does that mean?

  24. me commented on May 9

    Good luck with thoses shorts:

    From today’s FT:

    The rise in prices was even stronger in crude oil products, with diesel in Europe rising 2.7 per cent to $1,187 a tonne, a new record high. Demand for diesel is rising as developing countries, including China, South Africa and Chile, suffer power shortages and utilities rely more on diesel-fired power plants and generators.

    The market is increasingly concerned about a “super-spike” in oil towards $200 a barrel, with the number of financial bets on crude oil prices hitting that level before the end of this year jumping almost 40 per cent since the start of May.

    There were 21,002 outstanding contracts for Nymex December 2008 call options at $200 a barrel on Thursday, up 38 per cent since the end of April.

    Holders of the options would make a profit if the oil price exceeds that level by the end of the year. Since the beginning of the year, the so-called “open interest” in these contracts has jumped fourfold. The number of outstanding contracts at $150 a barrel is also rising sharply.

    John Lipsky, deputy managing director of the International Monetary Fund, said on Thursday that “inflation concerns have resurfaced after years of quiescence” due to soaring energy and food prices.

    Mr Lipsky added that the factor underlying the price increase in energy and other commodities appeared to be “fundamental” in nature. “This means that much, if not most, of the recent price increases are likely to prove durable,” he said.

    However, it added that low interest rates and the weakness of the US dollar had also contributed to the rise in oil prices. He said IMF research suggested that $25 a barrel of the current price of oil could be explained by the drop in the dollar.

  25. Mel commented on May 9

    Too many here refuse to accept peak oil–by the time demand goes down, so will supply. When President Carter wanted to tax oil enough to inspire new sources of energy, so many ridiculed him. Fifty cents a gallon then might have saved us a lot of money and soldier’s lives.

    We are now so short term focused, we are emerging as the super banana republic–looking for the next bubble–from Peter to Paul. We coulda been long term contendas–Stella!!

  26. dave54 commented on May 9

    Verbatim quote from (Dow Jones) MARKET WATCH : “LATEST NEWS 11:10 June crude last up $1.11 at $214.80/brl in NY”

  27. David commented on May 9

    I love ratios like gold/oil or perhaps better gold/S&P or whatnot. My problem with each ratio is figuring out if it’s logical. Perhaps I’m dense here, but why would a fiat currency alternative (gold) have to trade within a certain ratio for a commodity that depends on supply/demand? I can understand gold/stocks, as both are affected by inflation (inflated earnings, debased currency, etc), but I don’t get the gold/oil ratio. It’d be a lot easier for me to get a oil/copper ratio, as both are very dependent on industrial/economic demand.

    So, how stupid am I?

  28. deflator mouse commented on May 9

    “especially when some dude became the destroyer of worlds…”

    Okay, I’ll bite, what the hell does that mean?

    “I am become death, destroyer of worlds.”
    -J. Robert Oppenheimer, quoting the Bhagavad Gita after the Trinity atom bomb test.

    The introduction of nuclear weapons was a singularity in history. Things have been different since.

    Are you suggesting an “end-of-oil” singularity?

  29. DonKei commented on May 9

    Steve,

    Thanks for the reference.

    Are you saying human nature changed because humans discovered a very efficient means of destroying themselves?

    I’d disagree. The spectre of the end of the world has always haunted humanity, whether from asteroids or comets, or from global warming (recently), or from our own hand (w/ nukes). We have a latent need to fear the big things.

    What does this means for oil prices? The demand curve is not suspended just because it is oil. Higher prices will eventually yield lower demand, which will eventually result in a spiral downward in prices, the reversal of the positive feedback loop of higher prices.

    But thanks for the lesson on Oppenheimer. It was an interesting read to get to his quote of Hindu scripture. Oppenheimer was quite remarkable.

  30. farmera1 commented on May 9

    Speculation, whocodaknown. I venture to say that when any commodity gets scarce there is speculation in a capitalistic/market economy. In fact there is speculation even when commodities aren’t particularly in short supply. So what. It always was and always will be so.

    The smart and rich make money off the dumb and poor and idealouges. That is the way markets work. Like the fellow I heard comment the other day when he said man can not cause changes to the earth. That man will take that to the grave and he will suffer as he sticks with that line of thinking. After all our life style isn’t negotiable. So be it.

    Don’t like speculation in markets, move to Cuba they don’t have that problem there.

  31. DiverT commented on May 9

    This sh@# makes my head want to explode.

    One of the talking heads from the oil industry was on Bloomberg yesterday mentioned that the spare capacity in the world amounts to around 2% so any slowdown affects the price.

    A) If wer’e running out why has spare capacity increased?

    Once you consider the attacks in Nigeria, the cross border raids by the Turkish into Northern Iraq, the strikes in the North sea and the approaching Hurricane season in the Gulf it isn’t hard to see that a small drop in production can easily squeeze the total supply in the world market.

    A) Yes, if there was a supply problem. I have seen no lines or heard of any gas lines anywhere in world. I have also found out about VLCC for those of you that do not know these are large oil tankers (hording) storing oil offshore waiting for price increases.

    Of course, that is ignoring refining capacity which is also stretched and finally declining production in Saudi Arabia, Russia, North Sea, Mexico etc.

    A) If you believe this ask yourself why refiners in the US are cutting back on production right now. If you look at the EIA (US Govt) reports you can see that refiners are cutting back (85% capacity) producing oil in gas right now because of lower margins but the inventory of gasoline is increasing.

    Oh, and the oft used arguement about the current high level of the SPR is pretty poor – the drop in demand in the US that has led to an increase in the SPR is more than compensated by the increase in demand from China/India so global net oil demand is still increasing.

    A)The SPR is filled so this WH wants to add to it 700m b to 1B. It was filled last year 06/07…you know before we cut back not because…. we cut back.

    The weirdest thing to understand is how there are so many people who don’t understand the fundamentals of the oil price increase and blame it solely on speculation. The majority could find hundreds of reasons why the house price boom would continue on forever a few years back, but can’t seem to fathom the current commodity price boom.

    A) Because when your lied to enough its hard to know whom/what to believe.

    Finally, if anyone really wants to deny that oil prices will remain high then answer this question. Is it really in the interest for any of the OPEC countries to sell oil for less? In some cases oil is the only industry they have and given it is a finite industry they will want to get the highest possible return. So far, the importers have complained about the oil price, but haven’t yet cut their demand significantly. Until they do, why should the exporters ask for less for their finite product?

    A) No it’s not in OPECS best interest as they have stateed. That is exactly why the Saudies have been saying it’s not us! It is the speculators.

  32. steve commented on May 9

    >>>Are you saying human nature changed because humans discovered a very efficient means of destroying themselves?

    I agree with you. I’ve always hated that statement, “things are different this time”, because everything is always changing. What’s implicit in that statement is that “we” change or human nature changes, when it doesn’t. Even when there is a massive shock to the system people will wake up the next day, change the “software” in their brain, and move on to the next thing… like what’s for dinner. But things are “truly” different, in a constant state of flux. It’s easy to take the “things are different” view and take it too far, and come to the wrong conclusions.

    >What does this means for oil prices?

    Nothing. Except (I’m lecturing myself here) is that I bought oil in ’03, but once it became the talk of the town I bailed. But being a contrarian for the sake of being a contrarian is not the smartest move.

    All I know is that in ’03 it was easy to invest in oil. The “fundamentals” were inevitable i.e. a couple of billion people invited to the party. With very little speculation occurring at least from my perspective. If you had to invest in oil I would follow Jeff Macke’s advice on Fast Money.

    >Oppenheimer was quite remarkable.

    Not only did he do the physics for the bomb but he was the electrician for the buildings and did all the wiring when they were built.

  33. James Hansen commented on May 18

    This is starting to become very newsworthy. Guy Lerner had a take on this the other day that i thought was interesting.

Read this next.

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