Top Advisors Corner

Tom McClellan: Oil's Drop Bigger Than Called For, But Right On Schedule

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Crude oil prices reached a new multi-year high on October 3, and then started a dramatic drop. It has just now fallen for 12 straight trading days to reach the lowest close since December 2017. There are various theories about why this has happened, attributing it to comments from President Trump, OPEC chicanery, Iranian oil exports, falling demand, fracking overproduction, and all manner of other explanations. But few of those explanations address the “when” question, concerning why this is happening now. 

Thankfully, gold gives us an answer to that “when” question. But it is a decidedly imperfect answer. It gives us flawed answers about the magnitude of the moves, but excellent answers about their timing.

This week’s chart shows us how the movements in gold prices tend to get echoed about 20 months later in the movements of crude oil prices. It reveals that the crude oil price drop over the past 3 weeks is really the echo of a similar drop in gold prices 20 months ago. The difference is in the magnitude. 

Gold’s equivalent price drop 20 months ago was tiny in comparison to the 27% drawdown in crude oil futures prices. But the timing was right. So what gives with this disparity? Why should oil prices drop so hard now as the echo of a tiny drop in gold prices?

Focusing on that question can lead one to miss what had happened before, leading up to this big drop. Gold’s message said that oil prices were supposed to have topped in March 2018, but instead oil continued to make higher highs all the way into October 2018. The timing of the up and down movements was still right, but the continued move higher into October 2018 was not what gold said was on the script.

 And then, suddenly, oil realized what it was supposed to be doing, and worked extra hard to get back on track. “Oh, I’m supposed to be over there,” oil prices said. So is it really an alarming development to see the 12-day 27% decline? Or was oil wrong for being too high in the first place?

That is the right frame of reference to put this question into. One can easily argue that gold was “wrong” for not foretelling the magnitude of oil’s recent price decline. But the other side of that argument is that oil was “wrong” for being too high for too long, and thus having to drop really far to make up for that mistake and get itself back on track. 

Trying to point fingers at the higher high in oil prices being wrong or the drastic plunge being wrong can lead one to miss the point, which is that gold has told us when the dance steps should happen. And this drop is happening right on schedule. Next should be a corresponding rebound in oil prices, to match gold’s rebound 20 months ago.

Tom McClellan,
Editor
The McClellan Market Report
www.mcoscillator.com

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