On June 15, 2019, we published our Crude Oil Cyclical Trends (WTI). In that review, we said the following:
“Our assessment of the data, as is commonly the case, is to default to the most conservative scenario. In the case of the latest decline in the price of oil from June 27, 2018 to the present, we calculated the decline of -52.98% as a possible turning point for the price of oil. A decline to such a level would bring the price of oil to $36.40, an additional decline of -29.40%.”
As seen in the table that we provided at the time, there was precedent for the price of oil to decline to $22.71. We always start from the conservative view and that is why we utilized the -52.98% level as a target (the smallest decline for a full cycle). If we had applied the previous worst case scenario, we would have generated a decline in oil to $16.15.
As absurd as it sounds, oil stands at $14.62 and that is a rebound from a staggering low. Below, we project the upside resistance targets and provide strategies to employ if you must own oil related investments.
The chart below reflects the current upside targets for WTI applying upside resistance targets.
The upside resistance targets are:
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$43.16 (conservative target)
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$54.81 (mid-range target)
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$66.11 (extreme target)
We’ve added to the chart the time constraint that, assuming no further decline occurs below the latest low, indicates a new floor has been set. Once the time expires (December 31, 2021) the direction of WTI will only be up, typically to the next upside resistance level, by default. However, we have to acknowledge the fact that it is possible, though remote, that the price could languish form more than a year an a half below the descending $41.16 level.
Three Scenarios
#1: Decline Further
There is the off chance that the price of WTI could decline from the April 22, 2020 price of $14.07 and retest the prior low.
#2: Remain Unchanged
This is an ideal scenario for the average investor. Why? There are great companies with great assets and income that are severely underpriced. If, at minimum, the price of the stocks or land were to remain unchanged, then there is great opportunity for tremendous income, assuming a 50% cut in the pre-crisis level dividends is factored in.
#3: Increase From Here
This is the most speculative scenario as the risks between now and the eventual retest of the descending $66.11 resistance target are significant. However, those who understand and accept the government mandated phase out of combustion engines and potential declines in price, the market is handing speculators (as opposed to investors) a gift.
Our Take
By default, we assume that the price of WTI will achieve the prior low before going higher, which technically was a negative number. However, from a practical standpoint, we believe that while the potential for loss is significant, we would buy a substantial portion of a portfolio (minimum 10% : maximum 20%) of oil stocks that replicates the XOI index. Generally, this is best represented by the Vanguard Energy ETF (VDE) which hold many oil and gas stocks.
If, after the storm clouds clear, and the oil markets recover to their new normal, that would be the best time to engaging in the individual selection of oil stocks. For now, the best approach is to assume that the oil market is either going to decline further or remain unchanged for the foreseeable future.
If you’ve decided to follow our recommendation of 10% or 20%, accepting the risks involved, with a minimum holding period of 3 years, then we’d suggest putting half of funds in now and the second half at a later date.