Sunday Edition: Is The Oil Market Doomed Or Is There A Deep Long Term Value Play?

October 16, 2016

Sunday Edition: Is The Oil Market Doomed Or Is There A Deep Long Term Value Play?

Four safe companies yielding 3% – 6% revealed below.

It’s essential to understand that fundamental value will be only one of the factors determining a security’s price on the day you buy it. Try to have psychology and technicals on your side as well.

– Howard Marks

In my opinion, Howard Marks of Oaktree Capital is one of the savviest contrarian investors on Wall Street. It is in the spirit of trying to put the fundamentals, psychology, and technicals on your side that I’m sharing this series on the Elliott Wave Theory.

Last week we discussed how the theory consists of two cycle parts: impulse or motive wave and corrective wave. These two parts constitute the eight waves that make up a complete cycle pattern.


Smaller versions of a complete cycle link together to form an even larger version of another complete cycle pattern.

This is the “fractal” nature of markets that manifests across all financial markets and can be an effective way to identify the end of a bear market and start of a new bull market.

Today we are going to analyze a very long term complete cycle pattern in the oil market, coupled with a brief discussion on oil fundamentals, to determine what investment opportunities currently exist in the oil market.

The 18-year crude oil futures chart below, dates back to the 1998 low of $10.65 a barrel (oh the days of $1.06 a gallon gasoline).

I have labeled the two cycle parts; the impulse or motive wave (1-5) as well as the corrective wave (A-B-C). Notice the similarities between this 18 year pattern in crude oil and the 10-month pattern in gold and silver miners that we discussed last week, demonstrating the “fractal” nature of markets.

Source: TradingView.

From the 1998 low of $10.65 per barrel to the 2008 high of $147.27, crude gave back -88% of this massive run up in price before finally finding a bottom at $26 per barrel in February 2016.

Given the magnitude of this correction I would conclude that the bear market in oil is likely over. Does that mean you should back up the truck and bet heavy on oil and oil related investments? Not necessarily.

Take a look at the chart below and you’ll see a similar Elliott Wave complete cycle to the one shown above in crude oil futures. However, the chart below is of the now defunct Peabody Energy Corp (coal).

Source: TradingView.

Just because markets are patterned doesn’t always guarantee a profit when you buy the C point of a completed Elliott Wave correction. Especially if the correction is a multi-decade one that could indicate a company going out of business, or a structural change in the nature of commodity consumption.

I haven’t lived long enough to witness the complete demise of a commodity, but I have read about such things in the history books, whale oil being just one instance.

Do I personally believe that the current long-term fate of the oil market is the same as it was for whale oil? Probably not. However, new market forces that now confront oil—such as carbon emissions, electric vehicles, and solar and wind and eventually nuclear—have been and will continue to exert downward pressure on the long-term price of oil as consumers switch their consumption patterns.

You can read where we wrote about long term pressures on oil here.

Furthermore, anyone who has ever tried to pick a market bottom understands the term “value trap” in fundamental speak or “backing and filling” in technical jargon.

Markets, as well as individual companies can and do stay depressed for very long periods of time (think Cisco Systems), but that doesn’t mean you can’t profit from a depressed market, especially if you are an income oriented investor who prioritizes both capital preservation and high yields ahead of capital appreciation.

I want to be clear. I believe crude oil will remain a viable energy source for quite some time to come. However, new technologies will continue to increase the efficiency of well production as well as make alternate energy sources more economically viable, both of which will continue to put downward pressure on the price of oil, and in my opinion, keep crude range bound between $40 and $70 per barrel for the foreseeable future.

That doesn’t mean that the best oil related companies can’t increase both profits and market share in a range bound environment, as new technologies will also make oil producers more profitable on an ever decreasing cost per barrel.

There are several top tier companies which pay dividend yields ranging between 3% and 6% that according to the Elliott Wave Theory, as well as market fundamentals, appear to be at or near a bottom and provide a good margin of safety for your capital as well as a strong income stream, even if there isn’t much capital appreciation in the near term.

Here are a few names that I like and their current valuations:

CompanyTickerShare Price5 Yr. Avg. P/E RatioPrice to Book RatioDividend Yield
Western RefiningWNR27.357.251.626.6%
PBF Energy Inc.PBF21.7124.121.185.2%
Hollyfrontier Corp.HFC23.796.010.815.1%
Tesoro Corp.TSO79.987.091.892.9%

I believe long term value oriented investors should consider these companies as a potential investment opportunity for both income and eventually capital appreciation.

And if you don’t need the income now, you may want to reinvest your dividends, since they will buy even more shares at these deeply depressed levels. When the share price in these companies begins to recover, you’ll reap additional rewards for your delayed gratification and patience.

We also believe these kinds of oil related investments provide some of the best opportunities to sell put options to generate income. If we are assigned shares from a put option we have sold, we don’t mind since we collect a very lucrative income stream from both dividends and additional covered calls we may write.

Could these oil companies, as well as other oil related investments, prove to be a “value trap” over the next several years? Yes it’s entirely possible. However, given the high dividend yields and lucrative income streams, coupled with low valuations and what appears to be a long term complete Elliott Wave cycle bottom, the potential reward far outweighs the risk. And who knows, you might eventually pick up some capital appreciation too.


Shane Rawlings
Co-Founder, Investiv