If nearly 20 years in dealing rooms around the world taught me anything, it’s that traders, and therefore markets, have a tendency to overreact. When everything you do is about reacting to news and trends, it can be easy to read too much into each little nugget. Thus, when good news comes out, everybody piles on -- and when the news is bad, the rush for the exit is equally frantic.
That is certainly true when it comes to the shale oil boom in the U.S.
Earlier this year, as many of the oil exploration companies involved in shale oil reported good initial results from wells, and the price of both oil and natural gas was still high, everything connected with the industry went on a tear.
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As a result, the Market Vectors Unconventional Oil & Gas ETF (FRAK) jumped around 30 percent, from a February low of $26.85 to a high of $34.90 on June 23. Then, when a few wells fell short of expectations just as commodity prices wobbled, sellers took the upper hand.
The initial upward reaction was exaggerated by unrealistic expectations that the run of good results and high prices would continue, and this move down has also probably been overdone. Over time, the production of those wells will average out and prices will settle at a point where the companies involved can make a decent profit. Barring any unforeseen external factors, the shale boom will continue and finding a decent level to invest is a smart thing to do. Of course, knowing that a move is likely to be overdone is one thing; knowing when to take advantage of that is quite another.
When looking at a correction such as this and trying to decide how much selling is too much, traders frequently turn to a somewhat esoteric, mystical series of numbers, known as Fibonacci retracement levels. The Fibonacci sequence is named for a 13th century Italian mathematician and is a sequence of numbers where the next number is the sum of the previous two. Thus it begins 1, 1, 2, 3, 5, 8, 13, etc. Fibonacci retracement levels are derived from the relationship between the numbers in that sequence.
Without getting too deep into the math, it is enough to say that retracements of 23.6 percent, 38.2 percent and 61.8 percent are considered significant.
The rational among you may see no earthly reason why those numbers should be significant, and I would be inclined to agree with you were it not for one thing. They matter because those levels so often provide support or resistance when prices retrace. There could be something magical or mystical about this, but the most likely explanation is that they are significant because enough people think they are. It matters not what causes people to buy or sell at a particular level, but if enough of them do, then a point of support or resistance is formed.
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That is exactly what we are seeing in FRAK at the moment, and that prompts me to suggest that now may be a good time to buy the ETF. The faint dotted lines on the above chart represent the Fibonacci retracement levels, with the bottom one being the most significant, a 61.8 percent retracement. As I write, FRAK has touched that level and is bouncing back. That suggests it could be a good time to buy.
Of course, none of this has an ounce of significance if you believe that oil prices will continue to tumble, but there are signs there, too, that a bottom has been found with a bounce off of around $91 a barrel.
As of now, the situation in Iraq and Syria is having little effect on supply from the Middle East or the price of oil, but it is reasonable to assume that the prospect of escalation will limit the downside of crude for a while.
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If, like me, you believe that the shale oil and gas boom in the U.S. is really just beginning and that crude prices are unlikely to fall much further, then a long term holding in a broad based ETF that is focused on the industry is a good way to play those beliefs.
As much as some of you may be skeptical of trusting a 13th century Italian, a basic analysis of Fibonacci retracement levels would suggest that now is a good time to make that investment.
By Martin Tillier of Oilprice.com
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