Turning Charts Upside Down
A Teachable Moment for Oil Investors
A deep macro thought on my mind this week, before we get to the trades. The idea will impact those trades a lot, so this isn’t entirely just an academic exercise.
I’m finishing up a Howard Marks book. If you don’t know the Oaktree Capital manager, he’s a multi-billionaire whose ‘letters’ to investors have had wide impact and sometimes, he gathers those thoughts together into a book.
He has an ability to state his observations in a compelling way, while giving few clues as to his successful praxis. I’m not sure he could if he really tried anyway. But the point of this book is to recognize economic cycles around secular trends and supposedly ‘learn’ how to profit from them. And while cycles are pretty much 101 market knowledge for many of us, there is still a plus to finishing this book to remind me that they exist and shouldn’t stray far from my thoughts for long. Therefore, in Howard Marks style, here is the chart of oil since 2000 below:
My base case for the better half of my trading career has been that oil has been in a secular uptrend for several fundamental reasons easy to understand – natural and unstoppable scarcity, growing demand, increasing marginal costs, inflation, etc. Score some points for the RED line, above. I’ve written two books about the ‘bump’ in this trend line caused by the shale explosion starting in 2010 and becoming the primary market factor in 2014 – this certainly shifted the trend line downwards, but could not skew the fundamental upwards sloping nature of it and has (I think) oil headed ultimately towards $100 again, and above.
Reading Marks and the “certainty” of cycles, I started wondering, however. What if the entirety of the secular trend in oil I was relying upon was mistaken. I took to imagining what the chart above would look like if oil was in fact headed DOWN over the long term instead of up, as shown with the blue line above, begun with the speculative blow-off top in oil in 2008.
You can see that the cycling around that blue line is not only plausible, it actually looks far more ‘normal’ a pattern compared to my uptrend line, cycling rather regularly around it and maintaining the trend pattern without any ‘rationalized’ shifts I had imposed upon the red one. Further, the technical indicators associated with this chart would very much support that $75 oil is a cycle ‘top’ that’s to be respected – oil, at least from a technical point of view, should start downwards very soon towards $40 a barrel. Score two big points for the Blue line. And if I’m smart (and I’m supposed to be), I must consider that move a very real possibility if the Delta variant continues peaking and the world economy is headed towards a second ‘lock-down’ this Fall.
Let’s take a breath here, however, before we seriously question our underlying (bullish) oil trend. There could be only one fundamental reason why a downwards secular trend could be real, while the other false; That was if we were headed for a panicked rush towards renewables, which could only be the case if something catastrophic was foreseeable that was forcing a world-wide demand for the end of fossil fuel use and a build out of unprecedented proportions of sustainable energy production. And while the ESG movement is something to be reckoned with, that simply is not the case right now, certainly not here in the US. The facts just don’t support the hype surrounding the push towards renewables, no matter how dire you might see the current environmental situation – and don’t get me wrong, I see it as very dire, indeed.
So, what are our takeaways from all this? I think they are not as deep as I first thought they might be when I came up with this idea of turning our trend line upside down. I conclude that you can probably draw a trend line in any direction you want, given the chance to start it wherever you like, and then make a secular case for the line you’ve drawn after the fact. I’ve also concluded that Howard Marks is a very rich trader who has come to believe his own bullshit. Sure, there are cycles and you sure as heck want to buy assets when they’re cheap and sell them when they’re expensive. But Oaktree’s success isn’t due to one guy’s ability to recognize where those cycles begin and end, when others can’t. Instead, I think that he and other hedge fund managers are doing better research on the fundamentals of the economy and the companies and beating the ‘regular’ investor the old-fashioned way – finding value. And that’s not something that can be gotten out of any book, even if it is a compelling read and makes people like me do some serious thinking.
But here’s where that thinking DOES have some present value – in the trades I’m looking at this week.
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