Oil Top! A Long Time Forming

Name: Phil Flynn Company: PFGBEST

Years Trading: 25 Favorite Movie: Patton

Where is oil going? I am bearish big time but I am afraid the answer is a bit more complicated than just sell, sell, sell. Yes I am bearish but not before we work off some of our latent bullishness. To predict the fate of energy prices this coming year you really have to get a brief overview of what drove energy prices last year. Oil was not driven so much by supply or demand but driven by the largest global economic intervention in the history of the globe.  Global central banks around the world led by Fed Chairman Ben Bernanke went to extreme measures to bring the global economy back from the brink of what was the greatest global economic crisis since the Great Depression.  Along with that he created a bull market in commodities. Now oil is in the process of putting in a long term complex top. The problem is that it may take many months for it to complete.

The market is locked in kind of a dual trading range upper band and a lower band. The market seems to be on a longer term journey to at some point test the $85 a barrel area. Yet every time if fails it seems to push us back in a lower range to the low $70 a barrel area. If we close below $80 it will put us in the lower range and we could see oil get as low as $70. If we closed above $80 the market will try perhaps in vain to test what the bulls feel is it’s $85 a barrel destiny.

In other words the market has not one but two trading ranges that can be traded at the bullish or bearish trading mood of the moment.  Long term this market will head lower with a longer term test into the lower $40s. Yet we have to play the ranges until every last bull realizes that it is unlikely we can go above $85. If You Have the Patience and the confidence you can sell a rally and risk a close above $85 for a long term move to $44 of course in the mean time get ready for a long and bumpy ride. A ride that could take as much as 6 months Of course when the market finishes its toppy turning gyrations when the market decides to break it will be quick.

Why does the market have this dual personality?  It is because in many ways the bullishness in oil isn’t really real. It is a creation of the financial crisis. Take last year in oil for example.  It was a year when many oil traders had to forget everything they believed about supply and demand and so called wet barrels and dry barrels and had to focus on the intricacies of currency exchange rates and global macro economics. Traders had to view a barrel of oil not so much as a commodity but as pawn in one of the greatest economic comeback stories in the history of the world .Oh sure there were those that failed to grasp the fundamentals of the crisis and tried to blame speculation for all of the economy’s ills yet it is now clear to many in retrospect that markets acted just as they should.

 Traders had to think about the price of oil in a different way. That was hard to do as many had false assumptions about what was driving oil before that. If you remember how last year started on oil it was a time of great fear and uncertainty. The price of oil like a lot of other commodities and stocks was in the grips of a deflationary death spiral. Oil hit as low as $32.70 a barrel to start the year after a death defying plunge from the all-time high of $147.27 dollars per barrel. And that was nothing compared to the demand drop.  According to the Department of Energy the consumption of liquid fuels and other petroleum products in 2009 compared with the year before had one of the steepest declines on record. Consumption fell by a stunning 1.25 million barrels a day as fear and the destruction of demand permeated the market place. The economy was crumbling and we were losing faith in everything. Bank failures and auto-company failures, industrial production grinding to a halt as the greatest economy the world has ever known started to totally meltdown and the rest of the world melted along with it.

Yet despite the dire predictions and the fear the world would never have hope again the market came back. It came back as the Fed and world central banks came to the rescue hit the economy with massive amounts of stimulus. And the most significant factor that happen in 2009 and what will be the major factor for the price of oil in 2010 was the day in March when the Fed printed a floor under the price of oil. Or in technical terms the day the Fed went to quantitative easing.  The Fed lowered interest rates went as low as they could and to further stimulate the economy the Fed and other banks around the globe printed more money to try to stop the deflationary spiral.  The economy was very sick and the Fed had to go extreme measures to try to make it well. We exchanged deflation and hoped for a bit of commodity price inflation because the alternative was extremely bleak. As the Fed pumped in more cash the dollar lost value and commodities soared and oil more than doubled in price. People ran to gold and oil not like the year before when they were seeking safe haven from the credit crisis but because the dollar was falling. The subsequent commodity price rise along with the free flow of cash helped stabilize the banks and the economy and helped put an end to our deflationary mood. Quantitative Easing was the equivalent of putting the economy on a high powered drug to alleviate its fear and depression and stop the deflation mood that was making economy suicidal.

 And after that major injection of fiscal laughing gas we are now starting to feel pretty good. The world is looking more like the worst is over; we are all feeling a bit woozy but better. The deterioration in the jobs market is slowing and near record productivity suggests that we may be seeing job growth return. We have returned to GDP growth and the recession may be technically over.  Wow these quantitative easing and zero interest rate drugs feel pretty good.

Demand in China came back in a big way. China exports hit a record high as they imported a record amount of oil. Yet now it appears they are trying to slow that growth.  China realizes that the problem is that we cannot stay on these drugs forever.

Drugs can make you well but if you stay on them too long they will destroy you. In 2010 we will have to get off the drugs and it won’t be easy and we may have to focus on silly things in oil like supply and demand.

In the beginning the removal of stimulus will be a bearish event for crude. We will see the dollar rally and the fear that higher interest rates will slow demand should cause a major break in the price of oil. But after a big drop the low price of oil should create a buying binge creating the type of sizable swings and opportunities that we saw a year ago... The Price of oil at that point will be predominantly driven by improving demand but demand that has to be real demand inspired by low prices and not artificial demand created by fiscal stimulus. Oil could fall as low as the $40 handle before we see the prices rise .As the stimulus comes off and demand growth stimulus wears off the market will have to work off a glut of supply.

About the Author

Phil Flynn is Energy Analyst and General Market Analyst with PFGBEST (www.pfgbest.com). Phil is one of the world’s leading energy market analysts, providing individual investors, professional traders and institutions with up-to-the-minute investment and risk management insight into global petroleum, gasoline and energy markets. Phil’s market commentary, fundamental and technical analysis, and long-term forecasts are sought by industry executives, traders and global media.

Because he has been available to media around the clock, even during some of the most turbulent market periods in history, and because he has built a solid reputation for accuracy in his market analysis and forecasts, through thousands of interviews and broadcast appearances for more than a decade, Phil Flynn has become a headline-making name even as he continues to provide expert advice and customer care to his proprietary trading account clients.

Media highlights include: CNN, CNBC, Bloomberg, ABC, CBS with Katie Couric, NBC’s “Today Show” and “Nightly News with Tom Brokaw”, FOX’s “O’Reilly Factor”, PBS’s “The Newshour with Jim Lehrer” and “Nightly Business Report”, MSNBC’s “The News with Brian Williams”, Wall Street Journal Report, The Wall Street Journal, Business Week, Investor’s Business Daily, The New York Times, The Los Angeles Times, Chicago Tribune, Associated Press, The Toronto Globe & Mail, Houston Chronicle, Futures Magazine, National Public Radio’s Marketplace, a chat with the President of the United States, and many more venues.

You can read Phil’s daily market analysis and blogs at www.pfgbest.com.

PFGBEST is among the largest non-clearing U.S. Futures Commission Merchants, with customers, affiliates and brokerage offices in more than 80 countries. The company is a leader in sustainable investing through diversified products including managed funds, futures, forex, options, full-service and discount brokerage, trader education, market research, and direct online futures trading through its BESTDirect™ platform, and numerous other platforms and applications.

Phil’s commitment to and experience in futures trading is documented in two books, The Mind of a Trader (Financial Times/Pitman,1997), and Trading Online (publisher, date), both by Alpesh B. Patel. Phil is a lifelong resident of Illinois. He attended Daley College in Chicago before beginning his career on the trading floor of the Chicago Mercantile Exchange.

Phil Flynn
Phone: 800.935.6487
Email:pflynn@pfgbest.com