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In
previous commentaries we took a close look at the attributes of the 6-year
cycle, which is bottoming this summer.�
The 6-year cycle is a component of the famous 120-year Kress Cycle and
when it bottoms it tends to have a pronounced effect on stock prices and
often the economy.�
Right
now the 6-year cycle is the paramount consideration trumping all other
factors in the financial markets, whether it be the credit crisis, rising
food and fuel costs or anything else.�
For every cause must have an effect and when it comes to the markets
it�s the cycles that are the chief cause behind the effects we�re seeing.
Although
the 6-year cycle is primarily an equities market cycle it also has a
spill-over influence on commodity prices, especially the inflation-sensitive
oil price.� If we look at the long-term
price history of crude oil we can see that the 6-year cycle can be divided
into two halves of 3 years. �Further,
the first half of the 6-year cycle tends to have a depressing effect on the
oil price while the second half of the cycle typically has a lifting
effect.� Not surprisingly, the crude
oil price has been quite buoyant over the last three years which comprise the
second half of the 6-year cycle.�
To
get a better idea of what I�m talking about let�s look at a long-term graph
of the Nymex Crude Oil futures price.�
The following monthly chart, courtesy of Commodity Price Charts, shows
the monthly oil price from 1983 through 2002.�
Notice
that in the 3-year increments when the 6-year cycle is in the ascending phase
the oil price typically makes lower highs and lower lows.� During the three years of the 6-year
cycle�s declining phase the oil price tends to make higher highs and higher
lows.� Thus the 6-year cycle�s impact
on oil is the opposite of its effects on stocks and the economy during the
two phases of the cycle.
 
The
6-year cycle bottomed in each of the following years: 1984, 1990, 1996 and
2002.� Although the 6-year cycle
bottomed in 1984 and peaked in 1987, the oil price was subject to the
fundamental disinflationary pressures of the 1980s which skewed the cycles
effect in the oil price in those years.�
However, the peaking phase of the 6-year cycle in 1987 produced a
noticeable rally in the oil price as you can see in the chart and was no
doubt a contributing influence to the stock market crash that occurred in
October of that year.
The
last three years of the 6-year cycle from 1984-1990 is what is most important
for our present study: after a brief inflationary surge in 1987 and a
subsequent pullback in 1988 in response to the market crash of late �87, the
oil price proceeded to rally vigorously to a then all-time high of $40/barrel
in 1990 when the 6-year cycle bottomed.�
So here we find a performance that is typical of the oil price.� The last half of the 6-year cycle usually
brings rising oil prices.
The
6-year cycle that ended in late 1990 spawned another 6-year cycle that peaked
in 1993.� As per the norm, oil prices
were in decline from the end of 1990 through the end of 1993.� But from 1994 until 1996 when the 6-year
cycle bottomed once again the oil price was on the rise once again, rallying
from $14 to $27/barrel.� Again we see
that during the second half of the 6-year cycle oil prices tend to be in an
uptrend.
During
the first half of the next 6-year cycle from 1997-1999 oil made no net
progress.� It actually declined sharply
in 1997-98 as the effects of commodities deflation were felt from the Asian
currency crisis and LTCM hedge fund meltdown.�
During the latter part of �98 the price of crude oil fell to a
multi-decade low of $10/barrel and the retail gasoline price in many cities
was below $1/gallon.� This trend was
reversed during the second half of the 6-year cycle, which bottomed in 2002.� You�ll recall that the previous 6-year
cycle bottom ended a vicious bear market in stocks as well as an economic
recession.
Now
we come to the latest 6-year cycle.�
The current 6-year cycle began in late 2002 and peaked in the summer
of 2005.� Yet the oil price was in a
rising trend all during this time.� Was
this a negation of the 6-year cycle�s normally depressing effect on commodity
prices?� Not at all, for there is also
a 30-year rhythm in commodities which governs the long swings.� This 30-year commodities cycle was (and
still is) in its �hard up� phase throughout this decade.� There are also fundamental reasons
(China/India) and exogenous reasons (Middle East war) to account for the
long-term rise in the crude oil price.�
Yet
the rise in the crude oil price from 2003-2005 was relatively subdued
compared to the fevered pitch of the oil price spike in 2007-2008.� The past year-and-a-half have witnessed by
far the most extreme spike in the oil price since the 6-year cycle bottom in
1990.� I believe this can be ascribed
mainly to the influence of the final 6-year cycle bottoming process.� The influence of hedge funds have only
exacerbated the effects of the final descent of the 6-year cycle.
For
stock prices, the final �hard down� phase of the 6-year cycle has been bad
news.� For oil and other key
commodities it has been a source of significant buying pressure which has
lifted prices to multi-decade highs.�
When the 6-year cycle finally bottoms later this summer we will likely
witness a major shift in perceived value as money slowly exits the energy
markets and finds its way back into the drastically oversold equities
arena.�
Concerning
supply, in a recent editorial appearing in the Financial Times, Daniel Gros wrote that the supply of oil �will
increase not when the price today is high, but only if suppliers expect that
prices will be lower in [the] future.��
As Gros points out, the implication here is that China influences oil
prices today not so much because Chinese demand is currently high (Chinese
demand currently accounts for less than 10 percent of global consumption of
crude), but because demand in China is projected to dramatically increase in
the future.� This expectation,
according to Gros, is what is fueling expectations of higher prices and thus
leading producers to lower their rate of extraction today.
What
happens, though, when these expectations aren�t realized?� Is it just possible that producers and
speculators alike are putting too much weight on China�s economic strength
(and not enough on the 6-year cycle)?�
With the Chinese stock market down 50% from last year�s highs, the
implication is that an economic slowdown is soon coming to China (on the
theory that stock market direction predicts the future economy of the economy
by 6-9 months).�
Despite
the pronouncements of the pundits that China has largely �disconnected� from
the U.S. economy, there is still strong reason for believing that the U.S. is
leading China into a recession.� The
U.S. has been the first into the economic slowdown over the past couple of
years and will likely be the first to emerge from it after the 6-year cycle
bottoms, even as the other major economies are falling into recession.� Would it not be the ultimate �head fake�
if, after the summer Olympics in Beijing,� China�s economy began rapidly
cooling off and its demand for oil consumption declined?� This would indeed take much of the air out
of the oil price run-up.
Gros
also points out that �The expectation that prices can only go up (and the
fact that the return on capital remains low) is the real culprit� in the oil
bubble.� �A bubble starts when past
price increases lead to expectations of future price increases,� he
adds.� �It could very well be that
prices will not increase as much as expected if China�s future demand for oil
is lower than expected today, or if alternative energy supply sources become
as cheap as some suggest.�
Speculator
sentiment on crude is getting quite extreme on the bullish side of the
aisle.� Just last week the Financial
Times published a headline which stated, �Investors bet on oil at $300 this
year.�� That sounds like the type of
exuberant forecast that appears just before a major shift in momentum.�
The
article cited data provided by the New York Mercantile Excahge, which showed
that investors for the first time placed a small bet in July that West Texas
Intermediate oil futures would hit $300 a barrel � more than double the
current price.� Previously the highest
bet was $275 a barrel and $200 remains the highest bet with significant
investor interest, the FT said.�
Notwithstanding the current uptrend, I think it�s safe to say these
exuberant forecasts will be disappointed.
Clif Droke
Editor, The
Daily Durban
Deep/XAU Report
Clifdroke.com
Clif
Droke is editor of the weekly Gold Strategies Review newsletter, published
since 1998, which covers mainly U.S. and Canadian-listed gold mining equities as well as the
spot gold market and forecasts of market momentum trends, short- and
intermediate-term. The forecasts are made using a unique proprietary
analytical methods involving internal momentum and moving average
analysis. He is also the author
of numerous top-selling trading books, including "Stock Trading with
Moving Averages." For more information visit www.clifdroke.com
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