Holiday break for the energy market bulls?

By Benedict De Meulemeester

By Benedict De Meulemeester on 8/07/2009

Today, the price of Brent oil has dropped below 61 dollar. The technical charts indicate a bearish trend that started last week after prices had hit levels over 70 dollar, the highest of this year. In terms of percentages this looks even more impressive, prices have fallen by almost 15% in just one week. As prices are getting near the symbolic 60 dollar level, the following question pops up: is this another downtrend like we saw in the second half of 2008 or is it a short-term bearish correction of the upward trend that started last April?

To answer that question some comments on that uptrend of the past three months is due. It was remarkably quick. Prices had nearly doubled before most people even realized that they had stopped falling. It was the quickest rise of oil prices since 1991. This caused many people to cast doubt over the justification for this bullish sentiment. Wasn’t it just a case of speculation? I am always skeptic when people blame ‘speculation’ for price rises. I don’t believe that speculation has the force of moving the market on its own. Or to put it another way: I don’t believe that you can find a majority of people willing to invest in an uptrend, when the fundamentals point in the opposite direction.

Over and over I have seen that when prices rise, there was some fundamental shift in the real world supply and demand dynamics that caused this price rise. It looks like Chinese economic recovery was what caused the price spike in commodity markets of the past months. I was extremely surprised to see a graph in last week’s Economist that shows that Chinese industrial production is back at the same level as before the economic crisis. If this is true – and everybody knows how careful we should treat Chinese statistics – it is not strange that we recently saw a boom in demand for commodities. If the oil price history of the past five years has learned us something, it is that we in the West are often surprised by bull trends as we tend to neglect and underestimate the economic developments in China and their impact on commodity prices.

We should be very careful that we don’t repeat this mistake this time around. If you look at some figures, like citizen’s savers rates or the size of government stimulus programs, I wouldn’t be surprised that China recovers quickly from the crisis due to a boom in domestic demand while we in the West continue to suffer. I have witnessed the myopic vision on the world economy in many discussions with clients in the past three months. Western industrials found it very hard to believe that the rise of oil prices was justified because they themselves were still going to the deepest deeps of the economic crisis.

I don’t think that speculators can determine the fundamental direction of the market, but they can raise the speed. When commodity prices started to rise in April, this must have been a huge relief to fund managers all over the world. Since August 2008 their profession had become a nightmare. With oil prices back on the bull track, they must have believed that they could return to the good old days of huge profits in commodity markets. This influx of optimistic speculative money surely pushed up prices harder than fundamentals justified. Therefore, it is not strange that we see this current drawback. If you just looked at the graph of the oil price as an indicator of the shape of the world economy, you might have thought that what we saw in the past months was a miracle recovery. This surely wasn’t the case in European economies. Therefore, what we currently see is a normal correction. Or will it turn into something more than a correction? Ultimately that will depend on the appetite for consumption of people when they return from their holidays. I’ll tell you more about it in September …

The nice thing about such corrections of a bull market is that it gives people a second chance. Those that didn’t fix energy prices in February – March get another chance of locking in at nice levels. Let’s hope that the holiday period doesn’t refrain them from grabbing it!


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