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Could Oil Prices Intensify a Pending S&P Selloff?
COULD OIL PRICES INTENSIFY A PENDING S&P500 SELLOFF?
Courtesy of JW Jones
Last week we received reports that the unemployment rate in the United States was improving markedly. In addition, sentiment numbers were released that confirmed my previous speculation that market participants were becoming more and more bullish as prices in the S&P 500 edged higher. The exact numbers that came in demonstrated that bullish sentiment had not reached current lofty levels since February 11, 2011. The table below illustrates the most recent sentiment survey:
Chart Courtesy of the American Association of Individual Investors
Clearly investors are growing considerably more bullish at the present time. The bullishness being exhibited by market participants is rather interesting considering the notable headwinds that exist in the European sovereign debt markets, the geopolitical risk seen in light sweet crude oil futures, and the potential for a recession to play out in Europe.
To further illustrate the complacency in the S&P 500, the daily chart of the Volatility Index is shown below:
The VIX has been falling for several weeks and is on the verge of making new lows this week. If prices work down into the 16 – 18 price range, a low risk entry to get long volatility may present itself. For option traders, when the VIX is at present levels or lower, there are potentially significant risks associated with increases in volatility.
My expectations have not changed considerably since my article was posted last week. However, I continue to believe that the bulls will push prices higher in what I believe could be the mother of all bull traps. Let me explain. As shown above, we have strong bullish sentiment among market participants paired with general complacency regarding risk assets.
As I pointed out last week, I expect the S&P 500 to top somewhere between 1,292 and 1,325. A lot of capital is sitting on the sidelines presently, and if prices continue to work higher, I suspect that a move above the 1,292 price level will trigger a lot of long entries back into stocks or other risk assets.
We could see prices extend higher while the “smart” money sells into the rally. Retail investors and traders will point to the inverse head and shoulders pattern on the daily chart of the S&P 500 and the breakout above the key 1,292 price level. The pervasive fear of missing a strong move higher will help fuel long entries from retail investors.
While retail investors begin buying, a lot of committed shorts will be stopped out if prices push significantly above the 1,292 area or higher toward the more the obvious 1,300 price level. Thus, there will be few shorts to help support prices should a failed breakout transpire. A perfect storm could essentially be born from the lack of shorts to hold prices higher paired with the trapping of late-coming bulls.
The daily chart of the S&P 500 Index below illustrates what I expect to take place in the next few weeks:
It is not totally out of the question that the 1,292 price level could hold as resistance or that we could roll over early this coming week. Additionally, a breakout over 1,330 will certainly lead to a test of the 2011 highs around the 1,370 area.
If the S&P 500 pushes above the 1,370 area, we could witness a strong bull market play out. Ask yourself this question, what reasons could produce such a rally and what are the probabilities of that outcome transpiring in the next few weeks?
Obviously earnings season is going to be upon us shortly and if earnings come in below expectations, a potential sell off could intensify. Furthermore, economic data in Europe continues to weaken and slower growth appears to be manifesting within the core Eurozone countries like Germany and France. If most of Europe plunges into a recession, deficits will widen beyond economic forecasts and the strain in the sovereign debt market of the Eurozone will increase dramatically.
One key element that many analysts are not even discussing is the potential for higher oil prices to present additional economic headwinds for developed western economies. Clearly the situation in the Middle East is unstable, in particular, consider what is taking place in the Strait of Hormuz involving Iran. If a “black swan” event occurs such as a military conflict between the United States and Iran, or Israel and Iran, the prices of oil will surge.
In a recent research piece put out by SocGen, nearly every scenario that is referenced involves significantly higher oil prices. According to the report, the Eurozone is considering the banning of imported Iranian oil which could cause Brent crude oil prices to surge to a range of $120 – $150 / barrel according to SocGen.
The other scenario involves the complete shut down of the Strait of Hormuz by Iran. If this shutdown were to persist for several days, the expectation at SocGen for Brent crude oil prices is in the $150 – $200 / barrel price range.
Clearly if either of these two scenarios play out in real time, the impact that higher oil prices will have on European and U.S. economies could be catastrophic.
The daily chart of light sweet crude oil futures is shown below:
I am not suggesting that oil prices are going to rise or fall, just outlining the report from SocGen about where they expect oil prices to go should either of the two scenarios presented above play out. If oil prices were to work to the $125 / barrel level and remain there for a period of time, I would anticipate a very sharp decline in the S&P 500.
Currently there are a lot of headwinds for bulls, some of which could persist for quite some time. I intend to remain objective and focus on collecting time premium as a primary profit engine for my service at OptionsTradingSignals.com (sign up for free newsletter).
Once I see a confirmed move in either direction I will get involved. For now, I intend to let others do the heavy lifting until a low risk, high probability trade setup presents itself. Risk is increasingly high.
This material should not be considered investment advice. J.W. Jones is not a registered investment advisor. Under no circumstances should any content from this article or the OptionsTradingSignals.com website be used or interpreted as a recommendation to buy or sell any type of security or commodity contract. This material is not a solicitation for a trading approach to financial markets. Any investment decisions must in all cases be made by the reader or by his or her registered investment advisor. This information is for educational purposes only.
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Discuss:
Brent Yearly Average and Global net exports and Net Exports less Chindia
Export Land model assuming 0.1% PA decline in production for top 33 exporters 2010-2020
Export Land model assuming 1.0 % PA decline in production for top 33 exports 2010-2020
As you can see, if the top exporting countries have production fall offs greater than 1%, the oil on the market less Chindia will be cut in 1/2 by 2020...
The oil markets will be shut down in the name of "national security"....
Figures from J. Brown at TOD.
so what is your conclusion?
War or no war?
No war. Just the spectre of war. Better for markets and political elections.
I agree, no war, unless someone gets stupid. However, when you think God is on your side, anything is possible. The Cold War MAD doctrine was secular, therefore rational in nature. I don't think that applies here....
By no war, I mean, Isreal/Iran do not attack each other.... Will there be another war over oil? I'll give even-odds....
Increase in oit prices intensify pending S&P sell-off.
Is that really what We should be concerned about? I am concerned that this increase in price is a fore-warning of yet another useless war.
the name of the oil game, as all commodity games : price stablity is death to middle men traders. Frozen markets on supply side to feed growing demand, by central players, like oil company moguls; who ALSO want to put out financial fire of currency plays, the commodity margins explode as a result. Today the bitch is the debt mountain fed currency war between central banks: so commodities are hedges against the currency war. They serve two antagonistic oligarchies. Which makes the picture more complex. Who pours oil on the market, who tries to calm the fire? Its a mad world where the left hands are more numerous than the righteous right hand. So the roller coaster goes on, in Hormuz and in the ETF markets. False flags everywhere. Stay clear, let it lie low, then let the market blaze away at their mad initiative; as those who play with fire eventually get burnt. Oil and financial oligarchs feed the fire alternatively. If they gang up together it is not to calm the fire but to orchestrate it more openly. Win-Win via market manipulation until it becomes lose -lose big big time. That's what can kicking does, inevitably. You can't win in virtual fiat market if real economic margins follow laws of diminishing returns. We are there. Population explosion and commodity peaks are two natural barriers to current fossil fuel paradigm and its ability to efficiently hedge accumulated debt mountain from collapsing.
Oil is not infinite. If you believe it is, then go buy up Oklahoma's empty oil fields of the past and get rich.
Oil is not infinite, and if you accept that physical reality, you then have to start calculating at what point you can't get increasing amounts out to fuel an increasing population.
China buys 25 million cars a year. They are newly wealthy and there are no old cars being junked as new ones arrive. It's additive consumption each year.
At an amount of 500,000 barrels/day . . . added each year. Their present consumption is 9.3 mbpd. They'll add 500K bpd consumption by December.
Where is that new oil flow going to come from, especially if they refuse Iran's?
Refuse Iran's oil?
They don'y give a rats behind about our embargo.
Big picture:
Gloabl debt overhang creates semi-permanent threat of catastrophic deflationary dynamic...
This threat currently offset or held back by massive debt-creation (money printing) by CB's, which exacerbates the problem, but it is hoped that GROWTH will kick in to create enough productivity to pay down the debt...
If (scenario 1), oil reserves are plentiful, and IF peace remains the norm, growth will eventually kick in, and maybe, perhaps, a growth-inflationary dynamic will help draw down debt levels, and the globe eases out of the crisis with no real harm done.
If (scenario 2), oil reserves are plentiful and mid-east crazies start blowing each other up, oil prices spike, stopping growth in its tracks, and detonating global debt time bomb into deflationary death spiral.
If (scenario 3), oil reserves are vastly exaggerated, oil prices continue to rise in a pre-existing recessionary dynamic; growth is stifled,which increases mid-east tensions as certain players see window of opportunity closing; they must attack before their chance at "victory" slips by- oil price increases contribute to certainty of mid-east war, which in turn briings oil price shock, and debt bomb must explode.
1 in 3 odds- not bad for a racetrack, but not good enough for optimism on my part.
It seems wise to me to lay out scenarios as you have done, but I would question their nature.
Russia is the world's number 1 oil producer, not any of the Middle East countries.
Reserves are relevant, but they are not very important. You have to understand geology. If rock is very low permeability, and very high porosity, then there is a lot of oil in that rock, but it can't flow from pore to pore. Permeability can be viewed as the interconnectedness of pores. To get all of that oil, you will spend trillions of dollars drilling millions of wells with each well intersecting one or two pores, in each of which there might be 3 barrels of oil. The adjacent pores can't flow and 3 barrels would be all you get per well.
If you want to get all that oil from that low permeability field, you have to drill those millions of wells, and of course that can never work. But in terms of *reserves*, there would appear to be plenty.
So you may want to rethink your scenarios. It's a good way to think about the issue, but you have to have them correct.
Another pointer to lower oil prices??!!
Oil prices may be manipulated, but the quantity of oil reserves is not. We have academics with papers stacked up a million feet high saying so.
LOL at "peak oilTM" useful idiots.
Hey BR, didcha hit that abiotic gusher in your backyard yet??
The world clearly hasn't hit peak useful idiots.
I warned you....
Out of curiousity, when did God or Jesus tell you not to worry about Peak oil because "Dad" took care of it? Did he reveal this to you through prayer?
Are you one of the 25% of Americans that beliefs that Rapture will come within your lifetime?
What are you going to say to the Man when you meet him?
Or are you are just another one of those fuckheads that confuse ego with humility...
Oh hell they'll have half the population in tent city with DOW 36k and 7% unemployment in ten years.
I was thinking of buying little stocks today, but i changed my mind after reading your article! i can wait for a week or two and make thousands instead of hundreds
Just saw this posted a moment ago....
http://www.nakedcapitalism.com/2012/01/chris-cook-naked-oil.html
hey man! thanks for posting the link....
No
The other scenario is that the price of oil drops below $28 a barrel......which is the average price the SPR cost to fill. I don't think they have refilled it yet, since 2011 drawdown, so it is 30+ million barrels short at the moment....
Gonna be a bit pricey to refill it at $120+ isn't it?
$28 would also shut up all the oily sand-heads who are creaming it in and then promptly spending it all on gold plated SLR's.....
Bring on Rossi's ECAT!!
Hurrah!
What is the ECAT
On the E CAT - If this is turns out to be true, it deserves the hype that stupid Segway scooter got. Think of what it could do for the third world!!
If Ecat is true....it changes.....everything :)
Oil is a exception to the rule, even in a deflationary scenario oil will likely go higher, mainly because of all the inestability on the ME and because of the peak production. US economy stagnant with Oil=food going higher tha's a very ugly posibility. If oil go up, expect silver coming behind.
In the short term (6mo) I expect the opposite.