"Crude Awakening: Analyzing the possible Surge in Oil Prices"

9 juin

"Oil: No place to go but up"
A chart off oil for the last 50 years has never further deviated from its standard deviation compared over the cost of a risk-free asset such as the "US10Y".
This chart has only once ever reached its 2nd standard deviation once in the last 50 years.
Let first take a look at the first scenario to get a brief understanding of what this would mean for oil. Not to be ignored but equities, economics and politics combined.

Going back to an iconic year, the beginning of 1999. Nearing the end of the most significant bull run in equities history lasting 2 decades. Would see the S&P go up 10-fold from $100 to over 1000usd. To understand what would lead oil to deviate so far below its mean we would need to understand what lead the S&P to perform so well.
Of course, this would be situation of what some would say "the stars to align" and what would later be referred to as the "Goldy Locks Zone". At the for front was low geopolitical conflict, no major wars and economic stability would of course prime the events in which would occur.
Pulling the hood back and looking at what would be driving this surge in growth in the economy and equities would be a lagging effect of the USD no longer being backed by gold and this being matched with the lowering of interest rates. This 20-year period of low interest rates, lowering unemployment and lowering inflation would lead to a primed economy for growth in equities which in fact would negatively impact the price of such commodities as GOLD and Oil. This would see oil reach (unbeknownst to the people of its time) its 2nd standard deviation withing a 50-year period when oils compared to a risk-free asset "government bonds". It was soon to be know after as what was the beginning of some would refer to as a "Lost Decade".
In which 10 years later to the day if you had bought the S&P 500 SPX you would still be down a whole 45%. The Dow Jones Industrial average DJI was down 35%. Other well known and sort after companies such as Amazon AMZN had lost up to 93% and were still to be down 53% at bottom of the GFC all that 10 years later.

GOLD
It was not be all bad news, as some markets did perform dramatically and make a recovery. Gold would once again become highly sort after. At the start of the lost decade gold had been in a bear market for over 20 years. Since it was last sitting at all-time highs of $860 USD/OZ Gold lost a incredible 67% of its value and was sitting around $280 USD/OZ all that 20 years later. In the years to come people of its time would see gold have one of its most memorable bull runs. Throughout the next 10 years gold would break past its previous all-time high push up and past $1000 USD/OZ a 250% return only to be short lived. Being drawn down with the rest of markets and by the end of the 10-year period gold still stood at $715 USD/OZ and still up 150%.

UKOIL
Oil would also make history in its dramatic bull run starting at 10USD per barrel after two decades of price decline would later go on to form a huge bubble in oil and its price to top out at incredible $150 USD a Barrel and insane 1,500% only for its bubble to burst due to the GFC and return its pricing back to reality off less than 1/3rd of its previous pricing and found the bottom of the crash at less than $50 USD per Barrel. Still to be up 300% and far outperforming equities.

The second thing to understand about this comparison is to understand is the US10Y and its relationship to interest rates, inflation and the unemployment rate.

As you can see there is a high degree of correlation within these three metrics. US10y interest rates and inflation. The correlation these have with Unemployment is usually the inverse relationship. As unemployment goes up these tend to come down with interest rates being lowered as a measure to try stimulate the economy.
The inverse relationship

With unemployment looking to tick up it is expected that interest rates will not proceed higher therefore the US10Y to come down when the government decide unemployment is getting too big a tail wind.

The previous time the comparison was at its standard two deviation the unemployment rate had almost two years before unemployment rising would become a problem. So the government tried to cut rates possibly a little too early which lead to oil beginning to surge and being a main driver in inflation, inflation once again began to rise which again caused the government to raise rates again only to set of unemployment and rates to come down which in this case brought inflation down with it and what was to be the burst of the tech bubble that sent the economy spiralling back to reality.

However, in this scenario with unemployment rising already then, the possibility for unemployment rates to go out of control then raising rates therefore causing the US10Y to go higher seems to be out of the question. The only way UUKOIL/US10Y could possibly go lower is if the price of oil proceeds lowers or if the price of oil remains and the US10Y goes higher.
Which is not to say it is possible for this comparison to reach its 3rd or fourth standard deviation it just becomes more and more of an anomaly and is generally short lived met with high volatility.
This box highlights a more alike scenario of unemployment rising, inflation being tamed a little, rates hikes being kept stable and the UKOIL/US10Y comparison finding on its average.


Another observation is off oil being on its long-term support trendline. Also Finding support on top of its Along-term average.


Another chart that could also be a protagonist for an increase in oil or vice versa oil being a protagonist for increase in Energy is a false breakout only to be currently trading back up on top of it 50% retracement from its current highs is the S&P energy sector.


Obviously, nothing is of certain and to react and not to predict. So, a bounce or rejection of these levels is something that may want to be watched.