Oil and oil stocks have been one of the best-performing assets since the market bottom in the Spring of 2020. Of course, this follows many years of oil underperforming which intensified in 2020 as Saudi Arabia raised output to bring OPEC in line just as the world was falling into a recession as the coronavirus upended the global economy.
Oil plunged and actually went negative in terms of its front-month contract. However, this turned out to be a bottom. Supply was cut, but something interesting happened as demand stayed more resilient than expected. Overall in 2021, demand fell by around 10% while expectations were for 20%.
Now, demand is back to pre-pandemic levels, but supply was slower to return. This dynamic was exacerbated by Russia's invasion of Ukraine which sent oil prices past $135. A couple of weeks ago, we re-tested these levels.
Until then, any 10 to 20% pullback in oil was a 'buy the dip' opportunity. Currently, oil prices are down by a similar magnitude, leading some investors to believe that it's time to buy the dip.
To be precise, WTI crude dropped from $127 to $103 over the last 2 weeks. This drop has actually led to gains in equities as it implies that inflationary pressures are easing. While a bounce is certainly possible given how oversold we are on short-term timeframes, there is increasing evidence that the economy is going to go into a recession.
This means that all sorts of assets, connected to global growth, are going to suffer including assets with bullish fundamentals like oil, copper, or lithium.
Once, the market becomes convinced that something is going to happen whether it's inflation or a recession, then it's like an undertow that eventually pulls everything lower. This seems to be the case as nearly all assets connected to global growth are making new lows. Even most energy stocks are now below where they were prior to Russia's invasion of Ukraine.
So, investors should remain cautious in the short-term as a recession would likely lead to underperformance for many months until growth starts to rebound.
However, for true bulls, this could be a fantastic buying opportunity as it would likely exacerbate the supply issues. Oil is in the early innings of seeing production increase, but this could be short-circuited if prices plunge. And, it means that the next time that prices start rising, even higher prices for longer will be necessary to trigger meaningful investments in new production.