When Oil & Gas Analyst, Josef Schachter, says we are not yet in an Energy Bull Market, there is science and data backing up his theory. He has always been known for his “Bullish” bent towards the energy sector, but in the last few years his comments have been a “cold shower” in the face of what he calls the excessive optimism of the Bulls.

“Speculators and the media both seem to be in love with US oil stocks,” he says, “but the facts are that the Canadian Sector, savaged and ignored, has the strongest upside potential. Many Canadian companies have made the difficult decisions to position themselves for a new Energy Bull Market.”

Explaining the ‘irrational euphoria’ about oil and oil company stocks, Schachter says that speculators only seem to focus on one or two of the many indicators that support their bullish theory but neglect to see the warning signs of a material drop in oil prices, most likely driven by world stock market corrections. “It’s likely to be a sharp and relatively quick move,” he says, “but it will be painful for the already beaten up energy sector.”

He clarifies this with a few examples of what the bullish view is on a few important indicators and his opposing views for each:

INDICATOR #1: Healthy World Stock Markets
BULLS: Markets are stable and rising.
SCHACHTER: The internals of the overall stock market are weakening. Volume is rising on down days and on big up days with large price swings; volume is not rising much if at all above the selling volume. This is not a healthy stock market. It is overvalued, it is facing rising interest rates and the trade war policies of President Trump are escalating. After nearly 10 years of an overall Bull Market (from Q1/09) we are long in the tooth for a meaningful correction and are vulnerable to a quick and nasty plunge.

INDICATOR #2: Speculator vs Commercial futures positions
BULLS: Currently Speculators hold record levels of long positions in Oil futures
SCHACHTER: The Commercials (companies like refiners, utilities and chemical companies etc.) know the energy markets the best and are now short by a larger amount. Watch as the Speculators’ long positions decrease or when they start going short. Margin Clerks will start making the dreaded calls and speculators will have to sell to cover their positions. That’s when Commercial Investors will start buying long positions as they know cheapest prices are here now. In the tug-of war between Speculators vs Commercials, the Commercials have historically been correct.

INDICATOR #3: S&P Energy Sector Bullish Percentage Index
BULLS: In the engaging tryst between greed and fear, investors are currently in the greedy phase.
SCHACHTER: When fear finally takes hold, the markets and stocks, especially the oily ones, will plunge. When the indicator reaches 90 per cent Bullish, it’s time to SELL and harvest gains, but when it hits 10 per cent Bullish, clearly in the fear category, that’s the most opportune time to BUY. “This is a key indicator to watch,” he says.

The chart below shows that the transition from greed to fear happens quickly. In 2015 it dropped from 84 per cent to nearly 0 per cent in four months. In 2008 it went from 86.5 per cent to 4 per cent in three months. Currently it sits at 51.6 per cent down from 87 per cent just over two months ago. Schachter expects it to reach single digits in November or December 2018.

INDICATOR #4: Supply and Demand
BULLS: Many say that strong demand is driving oil prices higher, up to $US80 or $100 before year end.
SCHACHTER: The US Energy Information Administration (EIA) projects World Demand to grow by 1.8Mb/d which can be fully met by incremental production from the US alone, where growth this year is 2Mb/d. The Bulls say that inventory supplies are tight because OPEC lowered storage inventories to raise prices. While Saudi Arabia did lower exports to the US intentionally, the US grew by a greater amount.

INDICATOR #5. US Sanctions on Iran
BULLS: Sanctions on Iran will lower their oil production materially, perhaps 1Mb per day, driving crude prices much higher.
SCHACHTER: Iran’s economy is in tatters and they need the revenues. Europe is not in favour of these sanctions and they are looking for ways around the US controlled SWIFT system so they can buy the Iranian oil. If they can’t, Turkey, India or China could buy the extra oil as none of these countries are impacted by, nor care about, US sanctions.

Schachter considers many other indicators such as the US Dollar and 10 Year Treasury Yields. “They all play a part of this story,” Schachter warns. “These and several other indicators are all converging into the perfect storm for a sharp and painful plunge in the fourth quarter of 2018. Once that happens the new Energy Bull Market can truly begin.”

He suggests that investors who are already invested in Oil and Gas stocks, remain patient and hold some cash to buy at even cheaper levels. For those not yet invested, he says stay in cash, investigate the companies you are most interested in and wait. “Buy on weakness,” he advises. “Tax-loss selling at year end will provide some table-pounding opportunities.”

The Schachter Energy Report shows one-year targets for 29 covered companies that are significantly higher than today’s prices, and the much higher, five-year Bull Market Peak upside potentials for these stocks as well. Twenty-one of these companies will be presenting at the “Catch the Energy” Conference in Calgary, September 29, 2018.

Josef Schachter, CFA, is the author of the newsletter “Schachter Energy Report” and is a frequent/regular guest on BNN Bloomberg, Michael Campbell’s ‘Money Talks’ radio show, and the World Outlook Financial Conference. For more information about the conference, please see https://www.schachterenergyreport.ca/conference-2018.