Oil’s Well That Ends Well

This article was originally published on on December 18th at 12:00pm EDT

There are five stages of selling during a severe pullback like the one we have just witnessed in oil and energy-related stocks.

1. The Facts Come to Light (Two Months Ago)

Actual data points start to surface, which imply the price is too high — Oversupply (coinciding with a potentially problematic decrease in demand); Concerns that decreasing demand may indicate deflation in places like Europe and slowing growth in China and other emerging markets; None of the major producers (Saudi Arabia and other OPEC nations, Russia, Brazil, Nigeria, United States) seem to be blinking in terms of cutting production; and the U.S. dollar strength against all other currencies puts an unknown measure of downward pressure on prices. The PowerShares DB US Dollar Index Bullish (UUP), which reflects relative performance of the USD vs. a basket of other major currencies (euro, yen, Swiss franc) appears below.

2. Initial Fear (4 Weeks Ago)

How long can each of the facts outlined above persist? What if prices don’t find a bottom for another $10, $20, $30 or even $50 per barrel? What if oil, natural gas, propane and gasoline are in the process of becoming worthless to the global economy? I’d better sell now before everyone else finds out this information. Then they will start selling and the price will go lower still.

3. “Justified” Selling (2-3 Weeks Ago)

After the first round of selling, the apparent smart money comes in and determines what previously unimaginable black swans have now become visible, even probable. Market commentators say that because of how much exposure the high-yield bond market has to energy, a spike in both yields and defaults is inevitable. And now that the Fed is going to be imminently raising rates, a domino effect will be soon to follow, punishing those who reached for yield.

With depressed oil prices and a sure-to-freeze high-yield debt market, newer U.S. shale producers will be forced to shut their doors before they even put their names on them. OPEC has most recently agreed to maintain production at current levels (the very levels creating oversupply) and publicly stated that the next time they would be getting together to consider a cut would be six months out. Absolute carnage will erupt — get out now. Stop limits are triggered and stocks of profitable companies are sold 10-15% below where they traded a month prior. Nobody is buying energy shares.

4. Tax-Loss Selling (One Week Ago)

At this point, we are past the initial wave of selling and investors are in a sort of no-man’s land. At these prices it’s not really compelling to buy or sell. It feels like there may be some further downside, but selling now is slamming on the brakes while hydroplaning. Everyone knows you’re supposed to calmly ride it out. But is that really possible?

This is when we heard pundits and major financial institutions’ chief investment officers discussing on television how energy would be a great opportunity at some point in the future. Not today, of course, but at some point in the future. Right now it’s a falling knife.

5. Margin Calls/Forced Liquidations (Monday)

These are not transactions anyone wants to be making on the sell side. Accounts and funds that employ leverage to bolster returns must maintain a certain level of equity in their accounts and when that level is breached it’s time to raise cash. What gets sold in these instances is not necessarily what the account holder wants to sell, nor is it typically the time (or price) at which they want to sell it. Brent Crude Oil, the JPMorgan Alerian MLP Index(AMJ), the Energy Select Sector SPDR (XLE), and the SPDR S&P Oil & Gas Exploration & Production Index (XOP) through Monday’s close:

And then the bottom is in. The same positions through Wednesday’s close:

That’s how Tuesday and Wednesday felt, anyway. Because of yield support and some stabilization in the price of oil, it feels like we have reached and surpassed the point of maximum pessimism in the asset classes above. And in very short order. Could things get worse from here? Sure. Anything could happen and there are no shortage of catalysts for further geopolitical fireworks. But if you believe we just lived through Margin Call Monday, it may be a better time to buy than sell.

So what’s a barrel of oil worth? About $60 right now.

If you have questions or would like to engage in a dialogue, please don’t hesitate to give us a call.

Adam B. Scott
Argyle Capital Partners, LLC
10100 Santa Monica Blvd, #300
Los Angeles, CA 90067
(310) 772-2201 – Main

Adam Scott’s profile on RealMoney can be found here.

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