Big Crude Rally Raises a Contrarian Red Flag

The big surge in oil prices suggests underperformance could be imminent

Editor-in-Chief
Jul 9, 2018 at 3:34 PM
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The steep ramp in NYMEX WTI crude prices over the past year, as displayed on the accompanying chart, is as impressive as it is anxiety-inducing, given that this uptrend has translated directly into higher gasoline prices. As such, no one particularly wants to take credit for the big boom in oil; over the past week, President Donald Trump has faulted (via his Twitter account) the Organization of the Petroleum Exporting Countries (OPEC) for higher gas prices, while Iran's OPEC representative countered that Trump's tweets themselves "have driven the prices up by at least" $10 a barrel.

Against this backdrop, Goldman Sachs last week once again took the opportunity to espouse its bullish view on black gold. The investment bank thinks "the dollar will likely weaken from here," and said any impact from Chinese tariffs on U.S. crude exports will be quickly absorbed by the market.

But with crude oil having gained in the neighborhood of 66% over the last 52 weeks, data from Schaeffer's Senior Quantitative Analyst Chris Prybal throws some cold water on the bull case for oil. Looking back to 1978, Prybal found that in the 35 instances where crude oil was up by 50% or more on a year-over-year (YoY) basis, the commodity went on to underperform its historical average returns.

That underperformance was present at 10 days, 21 days, 126 days, and 252 days following a move above the +50% YoY level, but was most pronounced over those last two time frames -- which are equivalent to half a year's worth and a year's worth of trading days, respectively. Specifically, crude's average "anytime" return over a six-month period is 4.9%, compared to just 1.5% after a 50% YoY ramp. And at the one-year mark, crude is typically up 9.2% -- well north of the 3.4% average following a 50% annual increase.

And it's worth adding that Prybal's study also revealed underperformance in stocks following crude oil rallies of this magnitude. The S&P 500 Index (SPX) has delivered an average six-month return of 4.9% over the past 40 years, and an average one-year return of 10.0%. But following +50% YoY crude rallies, those average S&P returns have narrowed to 1.2% over the next six months, and 3.4% over the next year.

But what's lost by crude oil and stocks after these signals is gained by gold, which delivers stronger-than-average returns over every aforementioned time frame -- highlighted by a mean six-month return of 9.0% (compared to the 3.5% "anytime" average), and one-year returns averaging 12.8% (compared to 7.3% at any time).

With this data in mind, we'd advise traders to maintain a critical contrarian eye when it comes to crude oil. While the price action in the commodity has hardly broken down as of yet, it seems fair to say that quite a few of the fundamental concerns that have lately supported oil have been largely priced in, which could set the stage for a steady cooldown over the longer haul.

nymex crude yoy rally

Subscribers to Bernie Schaeffer's Chart of the Week received this commentary on Sunday, July 8.

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