What the Economy Is Telling Me About Oil Prices

By George Leong

Oil prices continue to edge higher on the chart, and that’s pushing the cost of gasoline higher at the pumps.

Now, while U.S. crude inventories have risen over the past two weeks, I do not believe there’s a supply-demand issue that is propping it up. I believe the demand for oil has more to do with the summer driving season and other unusual factors, not a sustained upward move in oil prices.

I also believe that oil traders are reacting more to headlines than the underlying fundamentals of the market. For example, a strong initial claim reading last Thursday drove up optimism that the economy is improving, but the real truth is the economy is stalling.

Remember the first-quarter gross domestic product (GDP) reading of 1.8%? That’s hardly indicative of an economy that is sizzling. That’s also why the Federal Reserve is not cutting its stimulus and why record-low interest rates are here to stay for at least another year. The economy is stalling and could worsen—and that doesn’t support higher oil prices.

Corporate America is not exactly reporting strong revenue growth. Did you see the numbers from heavyweights Intel Corporation (NASDAQ/INTC), eBay Inc. (NASDAQ/EBAY), and International Business Machines Corporation (NYSE/IBM)? The lack of revenue growth from these major technology companies means demand is lower and suggests the economy remains fragile.

The reality is that $100.00-a-barrel oil is just not realistic. I believe oil prices will retrench back to below $100.00 once the speculators who are driving up oil prices dump their positions and take their profits.

But what really stinks in all of this is the impact on gas prices. The high cost of driving means less disposable income for other consumer spending and less trips to the mall. The long-term effect will be on the economic recovery and GDP growth as spending declines.

Because of that, I will not be buying oil stocks or oil futures at this time. As far as oil prices go, I would probably be leaning to the short side.

The chart for West Texas Intermediate crude (WTIC) oil below shows the recent breakout around $98.00, which had provided strong selling resistance since February. The overextension is obvious and not sustainable, based on the underlying fundamentals.

I would expect oil prices to return back to the previous sideways channel below $100.00, according to my technical analysis.

Chart courtesy of www.StockCharts.com

So until the economy shows stronger growth, I would not be a buyer. In fact, I don’t really like any commodities at this time, as I think the commodity supercycle is dead.

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