It was therefore of great interest to me when a message dropped into my inbox from Dave Rosenberg, chief economist and strategist at Canadian wealth management firm Gluskin Sheff, a company that looks after the needs of high-net-worth private clients and institutional investors. Founded in 1984, the company has around $8.2bn (£5.4bn) of assets under management.
Mr Rosenberg is someone I greatly respect and has had the benefit of witnessing at first hand the trials and tribulations in financial markets well beyond my lifetime. What sparked my interest right now is that Mr Rosenberg believes that the oil price slump in 1985-86, when the price of black gold declined by 68 per cent from a peak of $31.80 a barrel on 21 November 1985 to a low of $10.40 a barrel at the end of March 1986, exhibits many similarities with the ongoing oil bear market. Indeed, Mr Rosenberg notes that “global economic growth back then was around 3 per cent, as it is now; neither hot nor cold. The oil market was riddled with excess supply, and the Saudis were not willing to close the gap”. It sounds a familiar story to the one we have seen unravel since the oil price peaked out at $115 a barrel last June. In both cases, the US benchmark crude price, West Texas Intermediate (WTI), fell by more than 60 per cent.
Using the 1985-86 experience as a template, Mr Rosenberg makes the important point that the performance of oil stocks leads the price, not the other way around – they bottomed out in the first week of February 1986, two months before WTI formed a price low. By the time WTI had troughed, oil stocks had already rallied 5 per cent. Moreover, the rally in prices can be very sharp. Mr Rosenberg notes that “six months after the low in oil prices in 1986, WTI had rebounded 42 per cent; a year out, it had surged over 80 per cent. From that oil price low, S&P Energy stocks rallied 27 per cent within six months and 50 per cent in the ensuing year.”
Interestingly, beyond focusing on what energy stocks were signalling, Mr Rosenberg observes that what was “most helpful in identifying the lows in the oil price in the early months of 1986 was to see that the 31 March 1986 low held in the inevitable re-test – and it is a process”. Indeed, the re-test occurred in early July 1986 after the oil price pulled back from a high of $17.50 a barrel at the end of May 1986, having rallied 68 per cent in the space of 53 days, to re-test the March low of $10.40 a barrel. That price held and two months later black gold had rallied over 50 per cent.
The important point Mr Rosenberg makes is that the testing process can be a multi-month affair, and of course there can be false dawns along the way with the peaks well defined and the plunges usually rapid. Furthermore, the oil price can sketch out a saucer-type chart formation in the process of forming its base from which it can then launch a sustainable rally. That’s of interest to me right now because the FTSE 350 oil and gas sector bottomed in mid-December 2015, and has since rallied over 16 per cent. However, WTI only formed a bottom of $44.20 a barrel a month later in mid-January, a price level that was subsequently re-tested on 29 January, around six weeks after energy stocks had bottomed, and from which the price has since rallied 17 per cent in the past six trading days. Of course, there can be no certainty that there will not be another re-test, but what can’t be disputed is that there are eerie similarities between the base formation in the oil price now and the one that formed in early 1986.
And in my view, that warrants having some exposure to a likely sharp snapback rally in oil stocks. It also explains why I decided to publish a column early on Friday morning last week which we flagged up in our invaluable IC Daily email to subscribers. If you missed that article, A slick operator, there is still 18 per cent potential share price upside on the table for the oil & gas producer and explorer I highlighted.
■ Simon Thompson's book Stock Picking for Profit can be purchased online at www.ypdbooks.com, or by telephoning YPDBooks on 01904 431 213 and is being sold through no other source. It is priced at £14.99, plus £2.75 postage and packaging. Simon has published an article outlining the content: 'Secrets to successful stockpicking'
