It is no secret that, since I first started contributing here, I have been somewhat bearish on the price of oil, or more specifically on West Texas Intermediate (WTI). That doesn’t mean that I don’t see long term opportunity in U.S. based oil stocks; I do, but the very thing that makes them attractive, the boom in oil production in the U.S. also, by definition, limits the upside to the price of oil, all else being equal. That seemingly contradictory stance has been vindicated, I guess, as WTI futures have dropped below $100, even as the energy sector has outperformed the broader market.
As with anything related to markets, though, my opinion is only valid until I change it, and I have…at least for now.
Now that WTI crude futures have dropped to around the $97 level it is beginning to look like we have found a bottom. Usually, when my overall view of a market changes it is based on a combination of factors, rather than just one thing, and this case is no exception. Three things have caused my change of heart; oil prices are at a clearly discernible level of support, economic conditions in the U.S. are improving, and there is a chance, albeit a slight one, that a significant regulatory change could take place that would give U.S. oil prices a serious boost. Let’s look at one at a time.
First, the chart point. I have drawn a simple trend line on this 2 year weekly chart from Stockcharts.com showing the upward trend in the lows of WTI crude. Technical purists may not like that it is a very inexact rendering, but it gives a fairly clear indication that a bounce off of current levels would follow the pattern established since the lows of November 2012. This is the kind of technical signal I like; one that is there for all to see. Chart points work because people act on them, so the more obvious they are, the better.
That bounce has been made more likely by increasing evidence that the economic recovery in the U.S. is gaining pace. The American trade deficit came in unexpectedly lower in June, and that news, in turn, has seen an upward revision of the already strong Q2 GDP number showing 4 percent growth in economic activity. Earlier this week, the Conference Board Index of U.S. Consumer Confidence rose to 90.9, the highest since October of 2007, and that is reflected in stronger than expected consumer spending. When taken together, all of this data points to a recovery that is gaining pace and that can only be good for the price of U.S. oil.
Interestingly, some of that reduction in the trade deficit came as the result of a fall in oil imports, and that gives a clue as to the possible joker in the pack that could push WTI significantly higher over the next few months, the prospect of an end to the ban on U.S. oil exports. I am not saying that such a thing will come about in the near future… let’s face it, anybody expecting swift, decisive action from the current U.S. Congress simply isn’t paying attention… but such a measure is looking increasingly logical and just a discussion of the possibility could drive prices higher.
These three factors, technical support, an improving U.S. economy and a growing move to export U.S. oil will produce an environment where the path of least resistance for oil prices is upward. I would certainly not want to be short oil futures in the coming months, then, and a position to benefit from increasing prices would be advisable. For most investors, however, who don’t trade futures, the next question is how to do that.
The simplest answer would be to buy an ETF that reflects U.S. oil futures prices, such as the U.S. Oil Fund (USO). The fund has a reasonable expense ratio of 0.45 percent and does an acceptable job of tracking oil prices.
Of course, no trade is without risk and if the trend line that I mentioned is broken, then a fairly sharp fall could ensue, so sensible precautions should be taken. I would look to establish a stop loss to protect against a break below the 52 week low, at say $32.50, which would limit potential losses on the position to around 10 percent.
I make no apologies for this abrupt reversal of my view on oil prices. A career in dealing rooms taught me that all opinions and views are fungible. When the situation changes, so should your view, and based on the three factors I detailed, the situation has changed from when I formed my bearish view. Oh, and by the way, if it changes again, I’ll change my view again, but hopefully not before booking a profit on this one!