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Why Crude Oil Investors Should Look Beyond Supply and Demand

Impulsive herding accounts for the volatility in oil prices over the past 35 years

by Bob Stokes
Updated: November 22, 2016

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[Editor's Note: The text version of the story is below.]

Oil bulls were smiling from ear to ear on Nov. 21. U.S. crude spiked upward 4%.

The reason?

This headline seems to provide the answer (CNBC, Nov. 21):

Oil prices rose on renewed optimism that OPEC was closing in on a deal to cut production.

This "cause and effect" explanation is not a surprise. Most energy market observers believe supply and demand drives oil prices.

Sounds logical.

But take a look at this headline from Feb. 16 (BBC):

Oil prices fell on Feb. 16 despite Saudi Arabia and Russia agreeing to freeze oil output at January levels if other producers follow suit.

In one case of a prospective tightened oil supply, prices jumped. In the other, oil prices fell. Likewise, when an increase in the oil supply has been in the news, prices have both risen and fallen.

The bottom line: It's a myth that supply / demand drives oil prices.

Let's take a look at supply / demand data from 1980 through 2015 via this chart and commentary from Robert Prechter's July 2016 Elliott Wave Theorist:

The chart depicts worldwide oil production (upper time axis) and consumption (lower time axis), respectively. The letters placed on these graphs indicate major turning points in the price of oil. See if you can guess which way, and how far, prices went each time by studying these graphs. I can’t do it. The list below gives you the price changes.

The Theorist goes on to say:

If supply and demand do regulate oil prices, one would think that shifts in supply and/or demand would have alerted economists to coming price changes. Did any of the 30,000 or so economists scattered over the earth use supply and demand analysis to forecast accurately the dramatic swings in oil prices over the past three decades? To my knowledge, none of them did.

Our view is that impulsive herding among speculators is what accounts for the dramatic swings in the price of oil over the past 35 years, not supply / demand.

This herding is reflected in the oil market's Elliott wave structure, and now is a crucial time to pay close attention.

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