The Economy and Crude Oil
By Frank Barbera CMT. March 25, 2008
Well, another week and another round of negative news. Earlier today, the release of the Case-Shiller Home price index showed U.S. home prices declining a record 2.4% in January, falling for the 18th month in a row and bringing prices down a record 10.70% in the last 12 months. Against the barrage of generally negative housing news over the last few weeks, it was no surprise that the 7:00am Conference Board release for Consumer Confidence showed a continued decline in March, with the index of Consumer Confidence falling to a reading of 64.50, down from 76.40 in February. Within the report, Consumer Expectations fell to 47.90, the 2nd lowest reading ever, down from 58.00 in March.
It is indeed an ironic twist of fate that just as several "contrarians" are suggesting that the crisis is over (huh?), that the directional data continues to plunge with expectations hitting the second lowest reading on record, with the lowest being the value of 45.20 seen back in December 1973. Footnote: December 1973 was the trough of the deepest US recession since the Great Depression and was within four months of President Nixon's resignation after the Watergate affair, truly a low point in this nation's history. Thus, we are amazed that in the face of data showing not only a recession, but the odds favoring a deep recession or worse, some folks still don't get it. In the chart below, we show the broad Consumer Confidence Survey for the Conference Board which this month confirmed recession with a decline below 70. In our previous update on the deteriorating economy back in late February, we noted that given the directional strength of forward leading indicators, the odds were overwhelming that the recession signal would be confirmed.
Above: Consumer Confidence Conference Board: Present Situation
As we can plainly see on the next chart, Forward Expectations have led the Present Situation curve at every major turn, and at the moment, the Present Situation curve is below its 20 month moving average and trending down very strongly. In addition, this curve is still A LONG, LONG WAY from anything close to a decade low. Given the magnitude of the Credit Market implosion, and the wealth already destroyed by the combined Housing and Stock Market Bear Markets, the odds are overwhelming that before the recession is over, the Present Situation Index will reach down into the 20's where it has bottomed deep recessions in the past. That means that the economy is still very likely facing another 14 to 16 months of negative economic news, which would place any potential recovery into the second half of 2009, or more likely 2010. Mind you, we are in the camp that what is unfolding is most likely a downturn of depression type size, and that those looking at this as just a "recession" are in for a potentially very rude awakening. We say this because, not only do housing prices still have a long way to go on the downside, but the further fall out likely ahead in Credit Markets is quite likely to be near catastrophic with talented economists such as Nuriel Rubini predicting nearly 3 Trillion in total losses before this is finally over. A good chunk of those will likely come from serious problems in the Credit Default Swap (CDS) market, where the problems likely began to surface last week with the collapse of Bear Stearns. This is a systemic threat, given the huge quantities of derivatives at play in the system; it is very likely that when the "daisy chain - domino style" reaction is finally over, we will all look back and wonder how such a monster could have ever been created.
Above: Consumer Confidence Conference Board - Present Situation (top clip) and Forward Expectations (lower clip)
Of course in our mind, perhaps the really big questions center on whether the Banking System will survive and whether or not the Dollar will collapse. At present, we believe that a huge Banking System crisis will be seen in the next 18 to 20 months, and that several large"mainstream" banks may end up failing. We also believe that the risk of a Dollar collapse is extremely high, and that an Argentina style Devaluation is brewing up like an afternoon thunderstorm in the tropics. Whether or not a deep recession evolves into a full out Depression may ultimately hinge on how much damage is inflicted on the Dollar as the falling dollar has been pushing up commodity prices over time, and in so doing, pushing down real consumer spending.
Of course, one big question to ponder when it comes to markets is how Oil will fare in an upcoming, perhaps global economic contraction. To this end, with the Oil market showing some signs of near term weakness, we thought we would spend a moment and try to understand where Oil may be headed in the months ahead. Back in October of last year, we noted that prices had come up against important price resistance and we took pains to note the complexity of the situation as we knew that the grudge match of an approaching recession versus a weak currency would be complex and dynamic to assess in real time. We stated,
"From an Elliott point of view, the advance has traced out a clear-cut five wave advance, which could recently have reached an important price juncture. At these levels, the risk-reward profile on Crude Oil is currently highly questionable and thus investors should "go slow" and step up monitoring of energy related positions. Mind you, we are not turning bearish on Crude, but simply believe that the market has come to a point where the most likely outcome is probably a trading range for a period of two to three months. Under different circumstances, with the threat of a US recession continuing to grow in our view, and over-extended market charts dominating the portrait of Asian markets, especially China, -- we could be turning actively bearish on Crude. Another element to consider would also be the proximity to former highs, which often act as price resistance. Yet, today's circumstance is radically altered by the recent turn by the Fed toward a policy of monetary easing. In doing so, the Fed is kicking out the support from underneath the US Dollar in a move for which they will almost certainly eventually pay for dearly. Opening the door to a currency crisis is no solution to a bad debt problem, except it spreads the pain over an even wider number of individuals, in this case, everyone holding dollars."
As it turned out, the weak Dollar carried the day, and Oil prices surged rapidly toward $100 before beginning a 9-week consolidation spanning early November 2007 to early February 2008. With the decisive movement into new all time high ground, the next question becomes, what does this imply for the larger Elliott Count on Crude Oil?
In our view, there are several possibilities open at the current time. One potential outcome would be to conclude that from 2002 to 2006, the Oil market traced out a large Primary Wave One which was sub-divided and was the extended wave. Within any five wave bull market, usually one leg becomes much larger than the other two, with that longer advance known as the "extended wave." It is possible that for Oil, Wave One was the "extended wave"and with the additional five wave advance seen between January 2007 and March 2008, that Oil is now completing Primary Wave 3, which is a much smaller advance. Under this outcome, we would then be looking for many months worth of downward corrective action to produce a Primary Wave 4. On the surface, this type of correction could easily last the balance of 2008 and into early 2009 with prices retracing 1/3 or more of the last 14 months worth of gains.
However, in our view, the Elliott count shown above has several major deficiencies starting with the fact that Wave One extensions are quite rare, and that where commodities are involved, most of the time the "extension" is seen in either the third or the fifth wave. In addition, take a close look at the chart below, which shows Crude Oil and the 52 week Rate of Change. At the bottom left, we see momentum levels "kicking off" the bull market in early 2003, followed by the huge surge in momentum which typically confirms the epicenter of a bull trend with the 52 week Rate of Change.
Above: Crude Oil and the 52 week Rate of Change Momentum Oscillator surging again in 2004-2005.
Flash forward to the right side of the chart, and what do we see? Once again, we see very high levels of momentum. This is clearly not any type of 5th wave action, and doubtful that this is the end of a Third Wave with such very high overall upside mo. Instead, the more likely outcome is that prices are still sub-dividing and building into an even larger advance, with the "extended wave" for Crude probably evolving as an Extended Wave Three.
Within that context, what could be at hand going forward would be the completion of Intermediate Wave One of Primary Wave Three with the downside correction of Intermediate Wave Two of Primary Wave Three dead ahead. Under this outcome, Crude Oil prices are likely to slump back toward the mid-$80's for a period of several months, tracing out an A-B-C sideways correction between $100 on the high end and the mid-$80's on the low side.
The full implications for a count such as the one shown in the prior chart really suggests that Oil prices could be headed much higher than most people would imagine in the years directly ahead. Of course, the advent of "Peak Oil" may very well be the primary driving force for sharply higher Oil prices even with a global recession. To this end, an extended Primary Wave Three could easily lift Oil prices toward $250-$300 per barrel by 2010-2011, with a final high for the secular bull market ultimately potentially pressing $500 per barrel. That would be difficult "indeed" as $500 per barrel of Crude would translate into roughly $11.75 per gallon of Gasoline at the pump and $11.00 for Heating Oil in the winter. Under that outcome, the cost of filling up an 18 gallon SUV would rise from nearly $72 per tank to more then $210 per tank putting the cost of simply driving a car to a much more taxing level for the entire consuming public. Going back to the early stages of Oil usage, we see that on the very long term chart for Crude, prices remain well within a very wide ascending trend channel. In the larger scheme of things, a Cycle degree Wave 5 is now underway for Oil, with high odds that prices culminate this bull market in the years ahead with a Peak Oil "blow off" up and outside the upper channel line.
Above: Crude Oil prices from 1875 to present, with long term Elliott Wave channel.
Cast against the backdrop of the long-term history of Oil prices, there are two other Elliott counts that suggest higher prices. If we label the entire 1980 to 2001 trading range as an A-B-C-D-E symmetrical triangle, a fourth wave triangle, then the following Wave Count is the best fit, showing the market a couple of months away from a rising "third of a third" advance. Usually, it is Wave 3 of (III) that produces the "point of recognition," the point where the masses finally understand what is really driving the advance. In this case, the concept of "Peak Oil" may be the dominant factor which alerts the public to the idea that Oil prices are simply not coming down. Alternatively, a heightened currency collapse and the de-pegging of Gulf State currencies to the US Dollar and dethroning of the US Dollar as sole commodity pricing currency could be other trigger events which could force Oil prices sharply higher.
The other count shown below, labels the correction from 1980 to the 1999 low as a simple A-B-C "Flat" instead of a triangle, with the bull market in Oil starting two years earlier. The bottom line outcome and implications are virtually the same, namely, that prices are likely to dip in the medium term toward the low $80's and then surge once again to still further rounds of new all time highs later this year or early next.
In our view, the corrective phase for Oil is most likely to last into the Q4 of '08 with prices likely resuming the advance to new highs early next year. As can be seen in the chart below, slowdowns in economic growth and bear markets, as was seen from 2000-2002, tend to have a depressing effect on Oil. In our view, the continued weak Dollar is very likely to counter-act most of the "recession" affect for this cycle, with prices only dipping to a modest degree. Technically, the thick line in red is the rising 200 week moving average for Oil and as long as Oil prices remain above that line, the long term trend is still strongly up. Near term, if prices were to break below the mid-$80's that would be a first serious negative, and would argue for a trip down to the rising 200 week MA which over the next few months will be between $64 and $65. While we do not expect it, any move below $65 would be outright bearish and would call in question the longer-range bullish case for Oil. On the upside, any move above $110 would be very bullish (less likely for now), but should it occur would suggest a further advance moving rapidly above $150.
Above: Crude Oil with 200 week moving average in red. $64 to $65 is now long term critical support.
Market indices ended the session mixed on the day, with the DJIA losing 16.04 index points to close at 12,532.60, with the S&P gaining 3.11 to finish at 1352.99. On the NASDAQ, prices rose with the NASDAQ Composite gaining 14.30 index points to end at a reading of 2341.05. The 10 Year Bond yield closed down .03 basis points to finish at 3.49%, while April Gold rebounded to finish at $935.80, up 17.10. That's all for now,
© 2008 Frank Barbera