Let us recap what we covered in parts 1, 2, 3 and 4 of this report. In spite of the low price of oil (just below $50 at the time of this writing) and predominantly bearish market sentiment, the “big picture” suggests that we are facing a grave energy predicament. Petroleum producing countries, especially members of OPEC, have been vastly overstating their oil reserves. Production of oil from conventional sources is in an irreversible decline. Over the next 15 years, the EIA projected that production will fall over 40% short of demand. New drilling technologies, and this includes fracking, are unlikely to impact this shortfall in a meaningful way. These conditions have led the UK’s Ministry of Defence to predict in 2012 that oil price could rise to as high as $500 per barrel over the next three decades, causing crises of unforeseeable proportions. For the oil market participants, the trillion dollar question is how to cope with the looming uncertainty and risks.
Here I will propose an elegant solution to this problem, but I must first make a confession: the present report is an updated version of the report I wrote in January 2015 when oil price fluctuated essentially where it is now (in the mid to high 40s). But, instead of shooting higher in accordance with the bullish fundamentals I outlined here, it almost halved, reaching the low of $27/bbl at the start of 2016. While I remain fully convinced that my analysis is correct and that we are likely to see much higher oil prices in the future, had I traded according to this conviction, I would have taken long exposure to the price of oil, sustaining devastating losses.
You see, in financial markets, doing your market analysis diligently and being right does not always pay off. Markets aren’t moved by the fundamentals, but by the way participants in the aggregate interpret market conditions. In other words, the moving factor is human psychology, not the objective reality. Driven by human psychology, the price discovery process often generates trends or even bubbles, as well as unexpected price collapses. Whether the market is “right” or “wrong” is irrelevant – all that matters to a market participant is whether he or she gained advantage or loss from the unfolding price events.
If there is one thing I have learned over these 20+ years trading commodities, it is to follow trends regardless of my own personal conviction. If the UK Ministry of Defence’s forecast of $500 barrel of oil comes to pass, the price change won’t happen overnight. Major price events almost always unfold as trends and trend following should keep you on the right side of the coming changes.
To help traders, hedgers and asset managers navigate the unpredictable market fluctuations profitably, I produce the daily TrendCompass reports covering over 200 financial and commodity markets, based on the I-System, probably the best trend following model ever built (here’s why).
Alex Krainer is an author and former hedge fund manager based in Monaco. Recently he has published the 5-star rated book “Mastering Uncertainty in Commodities Trading“.