Over the last 25 years, there have been five instances where West Texas Intermediate Crude entered the New Year in oversold territory as measured by the 10-month RSI, the monthly slow stochastic readings or both. The five instances occurred in January 1994, 1998, 1999, 2002 and 2009. In four of the five instances where crude entered the New Year in oversold territory, the commodity was sharply higher within the next few quarters.
In 1994, the price of crude opened the year at $14.11 per barrel. By August the price was as high as $20.98 which is a gain of 48.7%. In 1998, crude opened the year at $17.68 and pretty much continued to slip throughout the year. This is the only instance where oil was oversold heading into a new year and didn’t rally within the next few quarters.
In 1999, crude opened at $12.20 and was 50% higher by the end of May and was 100% higher by the end of September. It would eventually peak in October 2000 at a price of $36.90 per barrel. That is a 200% gain in 22 months. In 2oo2, oil opened the year at $20 even. By September the price had increased by 50% and by the following February the price had doubled. Finally, oil opened at $43.72 in 2009. By the end of May, the price had rallied back up to a high of $66.64 for a gain of over 50% and then it continued to climb and made it up to $87.15 in May 2010, just shy of 100% in 17 months.
As we get close to the end of December and the end of 2014, you can see that the monthly overbought/oversold indicators are the most oversold they have been in the last 21 years. It is also worth noting how oil has a propensity to get to oversold levels toward the end of the year. The only time we see a mid-year trough in either of the oscillators was in mid-1998. That also happens to be the last time the 10-month RSI was anywhere close to where it is now.
While oversold can become more oversold, it seems the odds of oil rallying over the next six to nine months are pretty strong. If you want more evidence, consider this: in a weekly scan of stocks and ETFs that are oversold and just experienced a bullish crossover of the slow stochastic readings, there were 129 stocks that appeared on the list for the week ended December 19, 2014. Of those 129 stocks and ETFs, 85 were related to the energy sector.
It isn’t just oil that is oversold, the stocks of oil producers are oversold as well as those companies in the oil services industry. In investing, your objective is to experience good returns with acceptable risk. We analyze stocks and the markets trying to get an edge and put the probabilities in our favor. Right now, the probability of oil recovering over the next 12 months seems higher than the odds for the sell-off continuing. Of course, even though the probabilities may be stacked in our favor, they still may not work out the way we want it to.
