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Analysis | Elliott Wave | Written by Elliott Wave International | Wed Oct 15 08 07:54 ET

$200 oil: How could have oil experts gotten it so wrong?

Three months ago, you couldn't swing a baseball bat in a crowd without hitting someone screaming that the world was running out of oil.

But after reaching a record high of $147 a barrel in July, oil fell as low as $77.09 (on October 10) - an almost 50% decline. And now, "Goldman Sachs, among those predicting $200 a barrel oil, cut its year-end forecast of oil to $70... " (AP)

How could have oil experts gotten it so wrong?

"To be fair, there is always a tendency in parts of the analyst community to look at short-turn trends and assume it's something that will continue in perpetuity," commented on the situation an analyst with the International Energy Agency.

Exactly. Isn't projecting short-term trends into infinity the definition of every financial bubble?

Bubbles are a function of our collective perception of reality - or market sentiment. "The prevailing sentiment," continues the AP article, "was that prices would continue to rise... " Three months ago, that sentiment made oil investors interpret just about every energy-related news story as bullish - and, ultimately, suckered them into a commodity bubble.

Avoiding such predicaments is precisely what Elliott wave analysis helps you accomplish. A study of market psychology, the Wave Principle helps you find psychological extremes in market charts - and then, ideally, forecast a change in trend before it occurs. A priceless advantage, indeed.

Here's how Elliott wave analysis could have helped you navigate around the oil bubble. On June 4, 2008 - still a month before oil's all-time high - Steve Hochberg, editor of Elliott Wave International's Mn-Wd-Fri Short Term Update posted this chart and commentary:

On page 8 of this month's issue of The Elliott Wave Financial Forecast, Pete [Kendall] and I published a chart of oil titled "A Gusher of a Top," whereby we argued that the wave structure and attendant optimistic sentiment extreme, as well as a test of channel resistance, conspired to indicate that oil was topping. One more sentiment signal that oil has probably finished it's upward run for awhile is this snippet of an article that I captured yesterday from Bloomberg news:

When the head of one of the world's largest corporations changes his entire product mix because of what he perceives as a "structural change, not just a cyclical change" in the price of gas... odds are high that a countervailing move is in the offing. Oil could conceivably fall by 50%... back into the area of the previous fourth wave, a common support area in terms of Elliott wave analysis.

Later, on August 11, 2008, The Short Term Update wrote:

Oil is down 23% from its July high. [This] chart was published in the June issue of The Elliott Wave Financial Forecast and shows our call for a top. Prices traced out five waves from the December 1998 low and carried to just above the upper line of an unorthodox parallel trend channel. Optimism was at near-record levels and the president of OPEC stated (shortly thereafter) that, "prices won't come down." It was a very strong confluence of conditions that indicated a reversal.

Near term, prices have closed lower the past two days, which is interesting in that if there ever was a fundamental "reason" for oil to shoot higher, it is Russia's invasion of Georgia. I believe that they even shut down a pipeline. When psychology reaches an extreme and the trend turns, all the supposed reasons pundits cited as to why prices were rising matter little. Nearly all were rationalizations to begin with, and the change in psychology exposes their flaws.

And that brings us to today. Here's an update on that oil chart from the June 2008 Elliott Wave Financial Forecast:

Now that oil has dropped 48% from its July peak - into the forecast area of "the previous fourth wave" - we may see market sentiment reach a low extreme. What will that mean for oil going forward? Steve Hochberg's Short Term Update, part of EWI's comprehensive Financial Forecast Service, provides occasional updates on hot topics in the news, such as his analysis above for oil.

But, if you want to stay on top of the daily twists and turns in the energy markets (as well as the long-term), you need EWI's Energy Specialty Service.

Elliott Wave International

 

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