One of the biggest questions on the collective mind of the market is “Where are oil prices going?” Perhaps no other commodity impacts the global economy in as far reaching a manner as oil.
Looking at oil prices today, one would think that there is a shortage or the inventory cupboard is bare. In fact, it is just the opposite – inventories in the US – the world’s largest consumer of oil by far – are full and then some. For example, it is estimated that just over 5% of the world’s oil tankers are being used as floating storage tanks by speculators who bought crude oil and are hoping to cash in on higher future prices. To say that the oil markets are a speculator’s playground might be an understatement.
If the markets were a simple entity, one could just look at supply vs. demand and calculate where oil prices should be going. However, since simplicity and market forecasting are seldom feasible, we can turn to inter-market analysis.
Simply put, inter-market analysis is looking at how different segments of the financial markets interact with one another and then determining if there is a relationship that exists that will allow for any observations to be made.
The chart below shows that relationship between the Oil Services Holder ETF (OIH:NYSE) and the price of oil. This particular exchange traded fund (ETF) is a basket of the largest oil services companies in the US. These are the companies that provide the offshore drilling platforms, land drilling rigs and provide the technical expertise that helps the oil companies to drill for energy.
(Data: Stockcharts.com – Click On Chart to Enlarge)
The important feature of this chart is that the blue line plots the relative performance of the oil services stocks against that of the broader stock market as measured by the S&P 500. Put another way, if the blue line is rising, then the oil service stocks are rising faster than the stock market and if the blue line is falling, this group of stocks is falling faster than the market.
With that explanation, we now turn to the black line – which shows the price of oil. We can see a very tight and well defined correlation between the price of oil (black line) and the relative performance of the oil services stocks (blue line).
Each time that oil prices tumble, the oil service stocks under perform the stock market. But when oil prices rise, they are a good place to be for investors.
However, what is interesting is that since May 2009 (right hand side of the chart), the oil service stocks have stopped rising even though oil prices have continued to pick up. This decoupling is of interest because it could be a harbinger of lower future oil prices. The words “could be” are emphasized because in the markets there are seldom certainties. Instead, there are probabilities and we tend to gain a lot by looking at historical inter-market relationships to get a sense of future direction.
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