Crude mispriced: But in what direction?

Fundamentally Flawed


Another failed upside breakout as the global oil market continues to wallow in this endless trading range. As the bull and bear frustrations continue to mount, I have heard traders on both sides of the market that tell me that somehow the markets are wrong and that the fundamentals do not justify the current price. In other words that the market is somehow fundamentally flawed and that the price is out of whack with either your bullish or perhaps bearish reality.


Oil bulls are frustrated with the lack of investment that they see in the oil industry and feel we are over estimating the drop in demand. They point to China and its explosive growth and its growing appetite for oil. They say that the market is not correctly accessing event risk especially with the type of talk coming out of Iran and Israel in recent days especially in the aftermath of European sanctions. The oil bulls say that despite the drop in demand that as the economy continues to recover oil supplies will tighten faster than you think. The latest to express that frustration was noted oil bulls Goldman Sachs who just recently exclaimed that crude oil prices are "significantly" below the level warranted by fundamentals. Goldman Sachs Group analyst David Greely complained that the balance between supply and demand in oil will continue to tighten in the second half of this year as global economic growth may boost demand, returning inventories to "more normal" levels toward the end of the year. Of course that came as Goldman had to reduce its near-term price forecast to the lower end of its targeted $85-$95 because of what they say is "still-fragile" sentiment in the marketplace.


Oil Bears will counter that oil is artificially high as evidenced by the global glut of oil that permeates the market place. Not to mention a global glut of spare production capacity and a global glut of spare refining capacity as well. Take recent data from the International Energy Agency that supports this bearish view. The IEA reported that oil stocks in OECD countries increased again in May across all regions and by a combined 35.0 million barrels hitting 2 757 million barrels or a whopping 61.0 days of forward demand cover. The IEA say s that it expects to see further increases in supplies in their next report. Yet on the demand side their growth expectations are very modest. The IEA say that global oil demand is only expected to increase by a very small 1.6% next year or a paltry 1.3 Million barrels. This is a far cry from the type of demand that would seem to support higher prices going forward.


So who is right? Is the price of oil fundamentally underpriced or overpriced. Well the truth is that the question is fundamentally flawed. The price of oil is always fundamentally correct assuming that you are focused on the correct fundamental. Oil and its price may not reflect as clearly the supply and demand fundamentals of the past because the price has been influenced or some might say manipulated by global central banks as they struggle to react to this global economic crisis. The price of oil is being influence not just by what is happening now but by what may happen in the future. If the economy gets better then the market feels that this will be inflationary according to oil bulls. Bears warn that if the economy gets too good stimulus will have to be removed thereby breaking the price of oil.
In fact it is this type of debate and trading that keeps oil range bound. The truth is that the market is pricing in both sides of this outlook and doing it well and that is why we are going nowhere. When the fundamentals seem to be wrong it is probably because you are not doing your homework. Or because the market itself is trying to hear both sides and adjudicate the eventually outcome.

And now the fundamentals are being driven by both bearish and bullish forces and that is the reason we are seeing one of the biggest sideways markets in decades. I am on record as saying that that I believe that eventually we will break out lower but in the meantime do not fight the fundamentals. Trade the ranges.

Phil Flynn is senior energy analyst for PFGBest Research and a Fox Business Network contributor. He can be reached at (800) 935-6487 or at pflynn@pfgbest.com

About the Author
Phil Flynn

Senior energy analyst at The PRICE Futures Group and a Fox Business Network contributor. He is one of the world's leading market analysts, providing individual investors, professional traders, and institutions with up-to-the-minute investment and risk management insight into global petroleum, gasoline, and energy markets. His precise and timely forecasts have come to be in great demand by industry and media worldwide and his impressive career goes back almost three decades, gaining attention with his market calls and energetic personality as writer of The Energy Report. You can contact Phil by phone at (888) 264-5665 or by email at pflynn@pricegroup.com. Learn even more on our website at www.pricegroup.com.

 

Futures and options trading involves substantial risk of loss and may not be suitable for everyone. The information presented by The PRICE Futures Group is from sources believed to be reliable and all information reported is subject to change without notice.


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