Crude Bubble?
From the Daily Reckoning
- "There's a bubble in crude oil!" wails a chorus of Wall Street analysts...
- "A sudden and violent crash in crude oil prices cannot be
dismissed," warns Thorsten Fischer, senior economist for Economy.com. Meanwhile, Bear Stearns analyst Frederick Leuffer staunchly maintains his forecast that oil prices will average about $25 a barrel in 2005.
- Yesterday's oil inventory report - and subsequent
sell-off in crude oil - lent some temporary support to the bears' argument. Crude supplies jumped 3.4 million barrels in the week ended Sept. 24, according to the Energy Department. The surprising increase in stockpiles triggered
the very first drop in crude oil prices in 10 days.
- Investors took flight from almost every corner of the
energy markets. Crude for November delivery slumped 39
cents, to $49.51, while gasoline and heating oil both
dipped a bit. Oil shares also suffered the blunt trauma of rapid-fire sell orders, as the XOI Index of oil stocks retreated 1% from its all-time high, reached Tuesday.
- Once again, investors face the daunting question: Is the
oil bull market over or just beginning?
- We freely admit that one man's bull market is another
man's bubble, but any commodity market that features constrained supply and robust demand would seem more bull than bubble. Despite the vociferous objections of oil bears
like Fischer and Leuffer, oil keeps chugging higher.
- Maybe it's true that a bubble is developing in the oil market, just as Fischer and Leuffer imply. But we submit that the bubble in denial is far more advanced... and dangerous.
- "Denial," broadly defined, is the psychological tendency,
either conscious or unconscious, to repudiate all or a
portion of the total available meaning of a phenomenon in
order to allay anxiety and to minimize distress.
- "Denial, like an umbrella, includes many defenses, such
as distortion, forgetfulness, rationalization, humor, suppression and so on," explains Dr. Simon Wein of the Department of Psychiatry at Memorial Sloan-Kettering Cancer
Center, "Implied in this definition is the belief that
denial is not always bad or maladaptive."
- Unfortunately, denial applied to financial markets is
almost always "bad and maladaptive" - also known as
"costly." Wall Street's obstinate, yet errant, forecasts
for falling oil prices are but one of many examples of the massive bubble in denial billowing before our eyes.
- Denial is pandemic. Consider the evidence... the lumpeninvestoriat holds the following "truths" to be
self-evident:
- Oil is overpriced, U.S. stocks are underpriced, real
estate always appreciates and a falling dollar is good for
the economy. Unfortunately, the lumps believed oil to be overpriced somewhere around $25 a barrel and believed stocks to be underpriced with the Nasdaq at 5,000. (So far,
their abiding faith in appreciating real estate and depreciating currency is serving them well.)
- The energy markets have been hosting widespread denial
for some time. One recently glimpsed chart tells the tale
of strikingly divergent price trends between the price of
crude oil and the price of oil stocks, as represented by
the XOI Index.
- On New Year's Eve 2001, crude oil changed hands for less
than $20 a barrel. One year later, the oil price fetched
more then $30 a barrel. Mysteriously, the XOI Index of
leading oil exploration and production companies FELL 10% during that time frame. Just two months later, the oil price kissed $40 a barrel, and the XOI Index was still languishing more than 15% BELOW its year-end 2001 level. Even today, as the price of crude oil flirts with $50 a barrel - or about 150% above the $20 price as of New Year's
2001 - the XOI Index has advanced less than 40%.
- Evidently, more than a few investors doubt the durability
of the crude oil bull market... even though it has endured
for nearly three years.
- Typically, during a lengthy bull run, resource stocks
will perform far better than the underlying commodities
they represent. For example, when the gold price jumped 50%
between year-end 2001 and year-end 2003, the XAU Index of
gold stocks doubled, while the HUI Index of "unhedged" gold
stocks more than tripled.
- No such confidence is evident among oil stock
investors... they're all about denial.
- Underpinning their evident skepticism evidenced is the
idea that a "fear premium" is causing oil to sell about
$15-20 above what simple supply and demand would dictate.
This notion is as seductive as it is misguided. Because the
threat of supply disruption is real and omnipresent, the
crude oil market deserves a "permanent premium."
- "In a perfect world," says oil analyst Bruce Lanni of
A.G. Edwards & Sons, "you'd take the premium out, and
you're looking at an oil price in the lower- to mid-30s.
But it is not a perfect world."
- There's a fact no one can deny. |
