Why Oil’s Bust will lead to the Next Boom

Wow, oil!

Its price continues to collapse, going negative for May delivery in the commodities market. That’s bleeping unbelievable and a direct result of the planet living the lockdown lifestyle. A real-life example of economics 101, supply and demand. There is no demand and an oversupply.

From experience, current conditions will lead to oil zooming if the world doesn’t get to work soon.

Here is why.

A lot of production will be shut down because oil needs to be around $30 a barrel for traditional oil companies to breakeven. Meanwhile, frackers need close to $40. As production moves offline, it means the supply will dwindle as well.

When the economy starts to heat up and demand increases, there will still be a glut of oil available. As such, oil companies won’t be in a hurry to bring more of the commodity to the market. At some point, demand will outstrip the vastly reduced production supply. And there it is, the supply cannot meet the demand and oil’s price takes off.

It’s the boom and bust cycle of the commodity. My worry is that the deeper the bust, the higher the rebound might be, which would be equally disruptive.
Investors with time horizons of at least five-years might start putting some dollars to the side to buy some blue-chip oils. Many offer fat dividends now and aren’t in danger of going out of business. However, we believe oil could still go lower, so dollar cost averaging (DCA) into oil stocks in the next three-to-six months could be the smart way to go.

(DCA is investing an equal amount of money at pre-determined intervals. For example, if you want to invest $3,000, you split the $3,000 into three monthly purchases of $1000.)

Oil’s faceplant pushed the major indexes lower to start the week. A little ‘self back pat’ here with the DOW and S&P 500 retreating after flirting with their 50-day moving averages. In case you missed it, here is what we wrote last week:

We see a couple of natural technical barriers overhead as the benchmark indexes aren’t that far away from resistance levels that happen to be neighbors with the indexes’ respective 50-day moving averages. The NASDAQ could run into selling at 8,400ish, the DOW between 24,950 and 25,000, and the S&P around 2,900.

By Friday, the DOW’s 50-day average moved down to 24,500-ish and the index peaked at 24,264.21. The S&P saw its 50-day slip to 2,850ish with the index topping out at 2,879.22. Meanwhile, the NASDAQ has been the leading index, which is the way we like it.

The tech heavy index smashed through and above its 50-day mark. At the close of business on Monday, the index is 216 points ahead of the short-term measuring stick of 8,344.70. Our short-term momentum model hints at more selling to come.

It would not be surprising to see sellers shave off another 4%+ in the days ahead, bringing the NASDAQ close to its declining 50-day number. We see support between 8,250-8,200 and the 50-day descent should put the average close to 8,250 by week’s end.

Short-term investors might consider inverse ETFs like ProShares Short S&P500 (SH). The ETF’s objective is to return 1x the opposite of the S&P 500 index on a daily basis. For example, if the S&P falls 2%, then SH should rise close to 2%.

More aggressive types could find the likes of ProShares UltraShort S&P500 (SDS), which tries to produce 2x the opposite of the S&P 500. For example, if the S&P drops 2%, then SDS is expected to increase by 4%.

Reverse ETFs can act as a quasi-short-term insurance policy against market weakness.
For now, profit taking is to be expected after a strong rally. While oil prices are very concerning as they are absolutely a proxy for the health of the global economy, many countries are in the process of trying to re-open. Oil future prices suggest Wall Street sees a demand returning as soon as July. The July Crude Oil Futures contract price as we type is $26.97. September is the first month with a price above $30.

In conclusion, money could come off the table in the near-term, but nothing out of the normal for now. Hopefully, the selling will stop well before hitting the previous low and the next rally takes prices above last Friday’s highs. That would be confirmation of the current uptrend and make us and investors happy.

May all your trades be profitable.

Rich Meyers