Even after dramatic fall in oil, in the wake of OPEC not cutting production, oil is likely to go lower in the medium-term. Here are the nine key points that every investor must understand. The bottoms are typically marked by heavy volume. Please note on the chart that the volume on this new low so far is only about 30% of the volume on the previous low. Further note that the previous low is about 12% below the current price and is likely to act as the first support.
Fair Value Of Oil
Based on the Quantitative Screen of the ZYX Change Method, fair value of Brent Crude is about $58.00. As of this writing Brent Crude is trading at $69.74. The fair value on this screen is determined primarily based on supply and demand.
Saudi Arabia Foreign Exchange Reserves
Saudi Arabia is the big swing producer. Its foreign exchange reserves stand at $278 billion. Its cost of oil production is under $10 per barrel. The point is that Saudi Arabia can easily withstand a price war lasting more than a year.
Relations between Russia and the West are strained. One realistic way Putin, President of Russia, can hurt the United States is by negatively impacting the shale revolution. Contrary to dooms day predictions for Russian economy, Russia can wage an oil price war for a long time. Its foreign exchange reserves $428 billion and further weakness in the ruble is giving it significant breathing room.
- S. Production
Falling prices are not going to curtail U. S. shale production overnight. Our estimate at The Arora Report is that irrespective of the price, U. S. production will continue near the present level for six months to one year.
It is fine to make arguments that falling oil prices are good for the world economy. However, our 30 years in the markets have taught us that asset prices including stocks and bonds do not always follow the economy. The big drop in oil price is a huge dislocation. Typically dislocations have unforeseen consequences. For this reason in our estimation, the risks in the stock markets across the world have gone higher. If deflation takes hold, the U. S. stocks can easily fall 20% to 30%.
Based on our analysis at The Arora Report, the big money still over-owns oil and oil stocks. Big money constitutes most of the institutions and large funds. Typically a bottom is seen in an asset class when big money under-owns the asset class.
It is important not to confuse smart money with big money. In our parlance, smart money constitutes a very small group of investors who know more, who know early, and who possess intellectual horse power to rapidly analyze new data. According to our algorithms, smart money has been mostly inactive in oil. Smart money tends to be aggressive buyer near the bottom.
Divergence In Time Frames
Investors can make hay by understanding the divergence in oil price between various time frames. In the short-term to medium-term price is likely to be lower but in the very long-term, the price is likely to be much higher.