Tuesday, July 8, 2008

$60 Oil and a 9000 TSX

On June 18 (just 3 weeks ago!) the TSX broke 15K and the bulls were out in full force. The TSX had now bucked the trend and had held up well in the face of a US bear market.

Today, we hit the "magical" 10% correction and erased all the YTD gains! With a 10% correction in just three weeks, I think the TSX is due to bounce and all the bulls are likely to buy their favorites again.

The TSX is a commodity play. If you can predict where oil and other commodities are headed, then you can predict where the TSX is headed. It is not a diversified index like the S&P500 and in a global bear market, any complacency about being up 10% YTD is crazy.

At the risk of sounding like a broken record, I talked about the risk to the TSX and commodities back on June 6,
May 16, April 21, March 20. Clearly in hindsight, I was too premature in most instances (perhaps not in June?) but the nature of bubbles are such that the blowoff phase can decimate bears and bulls that overstay the course.

I have seen what happened to some of the tech bears who shorted the Nasdaq in early 2000. They were ultimately right but they never lived to see the day. The blowoff parabolic phase can see enormous increases.

I am currently trying to study the signs to identify when a bubble is popping and when a bubble is simply in a correction phase. For example, the Nasdaq had some sharp corrections in January 2000 but then went much higher. Same for oil in late 2007/early 2008.

For the record, I agree with the esteemed John Hussman's analysis on oil. He throws out a possible $60 oil target. I believe that this is a reasonable target. Why?

1) First of all, the guy is good. But independently, I seem to recall oil being in the upper $60s last summer. What has changed since then to justify a doubling in price? Not much. Most of the developments seem to point to lower prices:

-Lower stock prices, lower housing prices, weaker economies, a massive credit crunch unseen since the 1930s

-Even the BRIC argument is weak as most of the emerging market stock indexes are down sharply, especially India and China

-Perhaps an Israeli attack on Iran would justify these prices. And even then, it would likely take a multimonth war to justify these prices.

2) $60 oil used to be high just a few years ago. I am not calling for $10 oil. $60 oil allows most oil producers to still remain profitable.

3) No one is even contemplating $60 oil. Even bears that I respect only talk about $100 oil.

4) We are on the cusp of a global recession/slowdown so demand is likely to tank. Add to that all the demand destruction caused by $145 oil, demand is likely to tank even further...

I have no position right now ("never short a chart that you can't ski down" is a famous quote I once read) but if we break $120, I would look for an opportunity.

If we get $60 oil and a bursting commodity bubble, the downside for the TSX would be unfathomable in my opinion. A 30% garden variety bear from 15K is 9000.... I don't know if this is where we go (we could easily go lower!) as all it takes is big moves in ECA, Suncor and Potash (to name a few) and you are there. And this 10% correction is nothing if we get a bursting of this bubble. Consider this yet another warning shot.

No positions at the current time

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