Oil

Will Oil's Upward Move Prove Short-Lived?

Motley Fool Oil rigs
Credit: Getty images

In Monday's Market Musings, I referred in passing to a market phenomenon known as “buy the rumor, sell the fact.” This is a common occurrence when a market rises as a positive rumor gains ground, only to drop back when the news breaks and it is confirmed as fact. That mention was in reference to the tendency of Apple (AAPL) to do just that as product launches approach, but there is potentially an even more glaring example of it right now in the oil markets.

This morning, oil futures are higher for the fifth straight day. That is the longest run of daily gains since July, and the reason for that move was the same as the current one: an approaching OPEC meeting. 

MM Chart 091019

In fact, there was buying as the last two OPEC meetings (marked by the blue arrows on the chart above). It went on for longer and was more marked the most recent time the cartel’s leaders met in July, but the meeting before that was, in context, just as powerful. That move up came during a major downward price adjustment, so the run-up of ten percent or so over the week preceding the meeting looked extremely significant at the time.

What can also be seen from the chart, however, is that in neither case did the upward momentum continue once the rumors became the news.

There are many reasons this happens so often. Some are slightly complex things specific to financial markets, but some are just plain old human nature. Among the second group, rumors tend to get exaggerated. When passing on gossip, the juicier it sounds, the better. 

Traders aren’t immune to that tendency, so what starts as a feeling that the current OPEC supply restrictions will be renewed and may be extended for a few months becomes a rumor that output will be cut even further and extended ad infinitum. Each exaggeration prompts a fresh round of buying, but the reality rarely matches the rumor.

When that reality hits, the selling, which comes as a result of disappointment, is exaggerated by something else. All markets have a speculative, short-term element, and those that bought on the way up as a trade rather than because of known future needs have to sell at some time. Thus, if the news fails to live up to the expectations, which it usually does for the reasons mentioned, there is a rush to exit long positions. 

That pattern can form in any market, but crude oil is particularly susceptible, largely due to the existence of OPEC. They are a body whose ultimate function is to prop up the price of oil, and when that is deemed necessary, they will do whatever it takes to achieve it. That has two effects on the initial, upward stage of a buy the rumor, sell the fact move.

First, the rumors are inherently believable, as everyone knows that propping up oil prices is the organization’s primary function. Second, OPEC learned a long time ago that their words are nearly as powerful as their actions. Much of their agenda can be achieved in the run-up to a meeting just by talking up their plans for pushing oil higher. As Thursday’s meeting approaches, for example, the new Saudi oil minister has made it clear that he is in favor of at least retaining the production cuts.

All of that has contributed to the “buy the rumor” that we have seen over the last week. But why does “sell the fact” also look likely?

Even following a run-up in expectation of an OPEC meeting, oil can sometimes continue higher after an announcement, as restricting supply from OPEC members pushes up prices from wherever they start. There are, however, three things that need to happen for that to be true. 

Firstly, the other side of the price equation, demand, must at least remain steady for lower supply to push oil higher. With the continued trade war and with Brexit coming to a seemingly ugly head, that is far from certain right now. Secondly, non-OPEC production must also remain constant so as not to replace the cuts. Based on the massive expansion of U.S. and other non-OPEC countries’ output over the last few years, that too is questionable. Thirdly, the agreed cuts must be enforced and adhered to. So far in this round of cuts that hasn’t been too much of a problem, but the deeper they go, the more chance there is that it becomes one.

The buying of crude on the rumors of further action at the OPEC meeting this week is well underway as WTI futures (CL) have gained over ten percent in the last week. If we take recent history as our guide and factor in the broader demand outlook for crude in the medium-term, however, the “sell the fact” looks to be only a couple of days away. It will probably pay to wait until just after the announcement to actually sell, as the immediate reaction will probably be upward, but before long, positioning for a drop looks like a decent trade.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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Martin Tillier

Martin Tillier spent years working in the Foreign Exchange market, which required an in-depth understanding of both the world’s markets and psychology and techniques of traders. In 2002, Martin left the markets, moved to the U.S., and opened a successful wine store, but the lure of the financial world proved too strong, leading Martin to join a major firm as financial advisor.

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