Where is Oil Headed?

Sunday morning. Its Memorial Day weekend. I had breakfast with a friend of mine visiting from Michigan. Nice crowd at IHOP as we discussed family, friends and investments. My friend is a contrarian investor. He said “take a guess as to where I am putting my money”… I replied Greece? Russia? The Ruble? He said “no… something in the US… Oil”.

After breakfast I went home and as I sat down to watch the Chelsea versus Sunderland, Premier league soccer game on TV, I looked up the ETF OIH, USL and the stock SLB. Charts for OIH and SLB are shown below. Looks like oil bottomed out – I see a double bottom on OIH and then the move up. We are now making higher highs, which is the classical definition of an uptrend. The uptrend is facing headwinds with the 200 exp moving average (black line) but the trend is certainly up nonetheless and is bouncing of the 50 exp moving average (red line). SLB has broken through its blue downtrend line and slowly climbing back upwards.

Fundamentally, there is global growth, which will continue to fuel the demand for more oil. Countries like Saudi Arabia, Iran, Iraq, Russia, and Venezuela will keep producing more oil regardless of fluctuating demand. When there is an oil glut and price drops, it will be the shale producers in the US who are “for profit” companies that will blink first and stop, reducing output and thereby again increasing the price of oil. Long term oil prices will have a bottom. That may be the double bottom we have seen or further down, but the nature of supply and demand will keep oil within a range. US is on the verge of being the largest oil and natural gas producer in the world but we are profit driven. When the price of oil drops, shale producers have to close down as they will not be able to sustain production at a loss for long. Also, their cost of production is likely higher than some of the Middle East countries. Short of a recession, I would expect oil to hold. 

I think oil and SLB are good investments for a contrarian investor. I don’t like the immediate technicals, such as OBV and the slower stochastics pointing downward. With some pull back, this should be a good buy and I think I will follow my friend’s suggestion and put some money into oil using the technicals to figure a turning point as well as a stop loss level.