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The Most Astounding News You'll Hear About Oil This Week

By Ian Davis
Saturday, August 9, 2008

It's official... Crude oil has entered a bear market.

OK, I know... filling up the SUV will still shrink the wallet. And I know the long-term trend in oil is still up.

But consider this: The price of the nearest crude oil futures contract closed at $146.60 in early July. It closed at $116.93 on Wednesday. That's a 20.2% decline... and Wall Street considers a 20% decline in any asset a "bear market" correction.

I believe the full correction will take months to develop. Speculative fever takes a long time to "wash away."

Also, the three previous oil corrections lasted an average 1.2 years. They've seen crude fall 61.8%, 53%, and 34.5%, respectively. As the bull market has developed, these corrections have become progressively shorter. But I still think we've got some time before this one comes to a close.

To figure out the best places for our money during periods of declining oil prices, I've crunched the numbers for every U.S. stock market sector during the three previous oil corrections. Here's what I've found...

For starters, the entire stock market tends to perform well as oil prices fall. Only 11 of the 101 sectors had a negative average return during the three corrections. Also, only two sectors fell all three times: the oil and gas exploration and production sector, and the oil equipment and services sector.

While 90 of the 101 sectors did well on average during past oil corrections, only 36 sectors rose during every oil correction. It will surprise you who did the best...

Best Performers During the Three Oil Corrections

Sector

Average Return

Worst Return

Reinsurance

36.8%

19.0%

Furnishings

32.3%

12.4%

Waste & Disposal Services

29.4%

11.8%

Conventional thinking says automobiles and airlines should be on the list. But these sectors only rose during the first and third corrections. During the second correction, they both plummeted.

The second correction occurred during the dot-com crash. Both automobiles and airlines are highly cyclical. When money is tight, people don't buy new cars or take as many flights, even if falling oil prices makes it cheaper to do so.

So why do reinsurance, furnishings, and waste companies do well as oil falls? Let's look at them one at a time...

Reinsurance is insurance for insurers. These companies pay out huge sums of money to regular insurance companies when a natural disaster hits.

Reinsurance and oil move counter to each other because of the weather. For example, if a hurricane is too tame to disrupt oil supplies (this just happened with hurricanes Dolly and Edouard), oil falls. Meanwhile, fewer claims are made upon reinsurance companies. So their profits and stock prices rise.

Furnishing companies tie to oil through their relationship with the housing market. Speculators bet falling oil prices will help cash-strapped consumers. More spending money equals more furnishings. (Home-construction stocks also perform well as oil falls. They returned an average 28.2% during the last three corrections.)
Finally, waste companies may benefit a little from lower oil prices because garbage and recycling trucks require large amounts of fuel. But after further examination, it looks like this sector's price movements are almost completely unrelated to oil price fluctuations.

Barring a sharp selloff in 1999, this sector has simply been in a long-term bull market. So yes, it appreciates when oil falls. But it also appreciates when oil rises!


Also consider a trade in home furnishings, homebuilders, and insurance.So how should you handle a correction in oil? First, avoid buying oil stocks for the next few months. They are clearly and directly linked to the price of oil, which I believe will keep falling. Oil services are particularly vulnerable. You'll be able to buy 'em cheaper before this correction is over.

Good investing,

Ian





Market Notes


AN UGLY CHART OF THE WEEK

This week, we featured two "euro bearish" essays, both written "boots-on-the-ground" by Dr. Sjuggerud.

The argument for a lower euro is simple: Just like stocks and real estate, currencies can get cheap or expensive relative to each other. Right now, the euro is as expensive relative to the U.S. dollar as it has ever been.

That's the fundamental argument. As you can see from this week's chart, the "technical" argument is shaping up nicely. The euro has broken down from a long sideways "base" started in March. 

Given the overvaluation, expect this breakdown 
to be the beginning of a tradable downtrend.

– Brian Hunt 



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