A Contrarian Looks at Crude Oil

Here is an image of today's front page of The New York Times. It is very unusual for a commodity market, even one as important as crude oil, to be the subject of a page 1 headline. So when I saw this I immediately cut it out and pasted it into my media diary.

How would a contrarian trader interpret this headline? Is there an obvious bullish or bearish investment crowd dominating the crude oil market?

The first step towards answering these questions is to look at crude oil's price chart. As I emphasized in my book, this is the single most important clue that reveals whether an investment crowd has formed in any market. (See page 112 of my book. ) I see two important things when I look at this chart.

First, the price of crude oil has doubled in the last few months. This alone makes it highly unlikely that any bearish investment crowd is dominating the market for crude oil. A 100% advance in price attracts bullishly inclined traders and investors, not bearishly inclined ones.

If no bearish crowd is in evidence, then how about a bullish one? Here too the price chart makes me skeptical about this possibility. Firs of all, the price of crude oil has risen for only six months or so, doubling during this time. In my experience this is just not enough time to get a bullish bandwagon rolling. Moreover, you can see from the chart that crude is still well below its all time high of $147 which was reached in July 2008. It is very unlikely that a bullish oil crowd will form unless and until the market approaches that $147 level. The situation now is in marked contrast to that which prevailed back in July of 2008 when crude established its $147 high. I discussed the peak oil crowd and its domination of the crude oil market on pages 23-24 and 70 in my book - those pages were written in late July and early August of 2008.

So right now I don't think the contrarian trader can interpret this New York Times headline as evidence for either sort of investment crowd. Still, the headline is intriguing. A very aggressive contrarian trader who is more concerned with shorter term price fluctuations might see this as an opportunity. Here's why.

The first paragraph of the headine story makes it clear that it is the doubling of oil prices that is the motivating fact for the headline. The article is all about extreme volatility in the oil market, but when it comes to commodities the real concern is upside rather than downside volatility. On page 59 of my book I talked about the emergence of volatility as a sign of the imminent demise of an investment crowd. These considerations all suggest that this headline can be interpreted as evidence for the existence of a bullish market crowd, although not one of a size even remotely approaching the one which dominated the market back in July of 2008.

So I think that a very aggressive contrarian would see this headline as evidence that crude oil is about to drop subtantially. On the price chart above you see the red line which is the 200 day moving average of crude oil prices. It is still headed downward which is evidence that crude oil is probably still in a bear market. In a bear market any bullish investment crowd is likely to be short lived. So the combination of the doubling of price over the past six months, the New York Times headline, and the declining 200 day moving average all point to an imminent drop in crude oil.

How low might it go? Well, since this is still a bear market my best guess would be back to last December's low near $35, if not lower.