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Crude Oil Biding Time Until Summer
Tom McClellan
McClellan Financial Publications, Inc.
March 27th, 2006

The top chart displays a relationship we have shown several times before, but we believe that it is so important that it merits repeated examination. Each time, we try to show it in a slightly different light, but the relationship remains unchanged in that gold prices tend to lead crude oil prices by about 11 months.

The exact correlation gets into temporary trouble whenever some geopolitical or meteorological force puts its thumb on the scale. But once that temporary factor fades, the two work to quickly reestablish their relationship. What this relationship says right now is that crude oil prices should remain relatively quiet throughout the first half of 2006, lulling motorists and others into a false sense of security, but then the big swoop upward in gold we saw at the end of 2005 should bring a similar upward swoop in oil prices in the second half of this year.

For those who don’t believe in that sort of predictive mumbo-jumbo, we offer some additional evidence in support of that hypothesis. The second chart on page 8 shows the spread between the current near-month crudeoil futures contract and the contract 11 months out from now. This spread is in negative territory now, which means that the out months are priced higher than the front month. In other words, futures traders are pricing in about a $4/barrel increase in oil prices over the next year. This sort of negative spread is a condition which is usually followed by a period of rising oil prices in the months that follow, a phenomenon which fits with the expectation of higher oil prices in the second half of 2006.

Interestingly, the major peaks in oil prices beginning with the Jan. 1997 top show an interesting Fibonacci sequence pattern as we highlight in this chart. According to this pattern, which up until now governs oil price tops, the “1.0” event is due to arrive around Dec. 27, 2006. That just happens to be almost exactly 11 months after the Feb. 2, 2006 top in gold prices, which fits with the relationship in the top chart. We do not know exactly what sort of news events will get the credit for pushing oil prices up aggressively in the second half of 2006, but we believe that the gold price run up stemmed from monetary forces, and those forces will have their echo in oil price movements according to the normal schedule.

The bottom chart shows that the retail investors at Rydex want little to do with the Energy Sector Fund. Its total asset level has been cut almost in half, despite a minimal decline in the fund’s net asset value. Investors appear to be giving up on oil prices going upward, which is all the more reason for us to expect them to do so.

Bottom Line: Oil prices are coiling now, preparing to launch higher during the second half of 2006.

The one scenario which could change the outcome for oil prices surging higher in the 2nd half of 2006 would be another geopolitical oil crisis arising before then. That was the case with Hurricanes Katrina and Rita, which caused a spike up in oil a couple months ahead of when it was due. A rebellion blowup in Nigeria, a terrorist attack in Saudi Arabia, or an action by the mullahs in Iran could all cause oil to head upward early. But the monetary forces which pushed gold up a few months ago are going to have their effect on oil whether or not any such geopolitical events arise.

Tom McClellan
Editor, The McClellan Market Report
email: tom@mcoscillator.com
website: www.mcoscillator.com
(253) 581-4889

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