Oil prices have rallied at the start of the year picking up note from media and market analysts. This rally looks great coinciding with the start of the year, but at these levels the fundamentals will be responsible for significant moves in any direction. Starting the year from an extreme sell-off helped pull the commodity up from the pre Christmas low, back to levels seen at the start of December. This level is an good example of dislocations in the markets temporarily creating opportunities to purchase assets at a fair price. We can look at this historical example to spot future opportunities.
The end of 2018 saw a lot of volatility enter markets and, looking back, created opportunities for entering into some positions. Spotting these trends and executing on them requires prior planning and building a case. Oil was in a decline from the start of October as too much supply started to pressure prices and fears about the global economy came to the forefront. As the markets came to the end of the year we saw an extended sell-off in risk assets and commodities when trade tensions between China and the US started to increase. But there were trends that weren't all bad that came from these extremes.
In the beginning of December, OPEC and Russia agreed to curb production as the US was hitting record production numbers. This news came after the majority of the swings in the price of oil and temporarily put a stop on fall in oil. Then, among light trading and trade fears the price started to drop dramatically despite fundamental news not coming out every day.
Making the assumption that you were looking to get into oil or oil commodities and determined that the news from OPEC and sanctions on Iran were good catalysts for an entry point (with some security knowing that the lack of high yield bond issuance was a good sign there wasn't aggressive expansion in the Fracking sector) you would now be watching this space. The relentless drop in the oil price would prompt you to look for data supporting that movement, inventories? flat to down in the US. Production? cuts from OPEC were to take effect in 2019. Downside risks include trade wars heating up and an economic slowdown.
Forecasts for a slowdown are present but not extreme, and the Fed came out more dovish on rate increases, providing some security that they will be willing to hold rates if conditions worsened. The US and China gave a 90 day extension to trade tariffs at the G20 in the start of December, providing some opportunity to reconcile before that time. This left oil in a good position to be bought in the violent downswing at the end of December. This doesn't mean it is a bottom, or that there is significant upside in the near term. Rather it was a good entry point with a margin of safety compared to the fundamentals at this time.
So how can you use this hindsight to look ahead? Looking at what opportunities may lie ahead and building a story is the first part. Is volatility coming back into the markets and now is a good time to buy protection in the form of puts because of low volatility? Are retails stocks looking cheap after Macy's caused an industry-wide selloff yesterday? Now is the time to start looking into these answers and waiting for a shorter term dislocation in the market to start building a longer term position.