Authored by Lance Roberts via RealInvestmentAdvice.com,
In 2013, I began warning about the risk to oil prices due to the ongoing imbalances between global supply and demand. Those warnings fell on deaf ears as it was believed that “oil prices could only go higher from here.”
It didn’t take long for those predictions to play out. In May of 2014, I wrote:
“While it is likely oil prices could get a bit of a bump from a decline in the U.S. dollar, ultimately it will come down to the fundamentals longer term. It is quite clear that the speculative rise in oil prices due to the ‘fracking miracle’ has come to its inglorious, but expected conclusion…It is quite apparent that some lessons are simply never learned. “
Of course, as with all things, particularly when it comes to commodities, it doesn’t take long for speculation to once again grab hold and drive prices higher in the short-term despite the long-term fundamental problems which still exist.
In September of 2017, I wrote a piece reviewing those fundamentals.
“I have been getting a tremendous number of emails as of late asking if the latest rally in oil prices, and related energy stocks, is sustainable or is it another ‘trap’ as has been witnessed previously.
As regular readers know, we exited oil and gas stocks back in mid-2014 and have remained out of the sector for technical and fundamental reasons for the duration. While there have been some opportunistic trading setups, the technical backdrop has remained decidedly bearish.”
The conclusion was not what most were hoping for.
“While there is hope the production cuts will continue into 2018, a bulk of the current price gain has likely already been priced in. With oil prices once again overbought on a monthly basis, the risk of disappointment is substantial.”
Well, here we are wrapping up 2018 and the prices of both energy-related shares and oil have been disappointing.
The expected decline in oil prices is more important than just the relative decline in share prices of energy-related stocks. As I wrote previously, energy prices are highly correlated to economic activity. To wit:
“Oil is a highly sensitive indicator relative to the expansion or contraction of the economy. Given that oil is consumed in virtually every aspect of our lives, from the food we eat to the products and services we buy, the demand side of the equation is a tell-tale sign of economic strength or weakness.
The chart below combines interest rates, inflation, and GDP into one composite indicator to provide a clearer comparison to oil prices. One important note is that oil tends to trade along a pretty defined trend…until it doesn’t. Given that the oil industry is very manufacturing and production intensive, breaks of price trends tend to be liquidation events which have a negative...