Oil prices: Time to rebound

This is the first article about oil. Previous analyses prioritized the discussion of the US Dollar and neglected the exciting deflationary trend in commodities. Indeed, all major commodities have dropped 50+ % since the summer of 2014 and such a rare move (similar to the crash of 2008/09) caused a heated discussion among economies and analysts about the possible reasons for the unprecedented decline. Oil price development is one of the biggest conundrums, respectively.

Some of the “fundamental” reasons for the oil price decline are as follows:

1. The problems with the Chinese economy and the corresponding commodities demand decline (China is the largest consumer of commodities in the world).

2. The Iran deal which ends the oil embargo. Once Iran starts exporting again, global supply is increasing which brings prices down.

3. The booming oil industry in the US leading to oversupply of the commodity.

One of the main problems with the “fundamental analysis” is the its inability to catch the reversal points of a trend. Such analysis has no precision and a very limited forecasting ability.  When the price of oil was topping, economists and analysts established a consensus opinion explaining the reasons for its increase. The initial stages of the downtrend created a confusion followed by (once again) a consensus opinion why the price should continue declining. The herd is always confused and the extreme pessimism occurs at the bottom. Recently, a major global investment bank predicted a price of $20/barrel in the near future. Many people get paid to linearly extrapolate the trend and listening such experts is the fastest way to ruin the value of your portfolio.

It is worth noting that most of the oil price decline happened without obvious “fundamental” reasons. While oil was crushing, the Chinese stock market bubble was still inflating. The Iran deal took place almost at the bottom. The US production oversupply qualifies as an issue but hardly anyone can explain why years of oversupply resulted in a sudden crash of unprecedented scale instead of a gradual price decline in alignment with the slowly changing fundamentals. Look at the chart and you will see how irrelevant these factors are. They failed to predict most of the decline.

oil rebound

Oil price development and market mood

The weekly chart clearly shows a completed 5-wave pattern. The so called “Prechter point” occurs in the middle of wave 3. This is the point of general mood change. Remember, price depicts mood in investing markets and dropping prices show an increasing pessimism. Optimism prevailed prior to the Prechter point (see the vertical red line). Once the decline matured, analysts and economists turned bearish. Now, they are ready with a list of reasons justifying a further price decline but it is too late. It already happened.

The completed 5-wave pattern together with the divergence in momentum and the extremely negative bearishness support the case for a temporary bottom. According to the Elliott wave model, oil prices need to correct the decline. This is expected to be accomplished by a 3-wave pattern as shown at the chart. The initial price increase in the last several trading days follows an impulsive structure; hence, further increases are expected. The expected price target is within the price range of $65-$70/barrel which coincides with the end of wave 4 from the previous decline. This is approximately 50% increase from the current price levels. Large trend moves require large corrections and PT expects a multi-month correction move.