If Oil Breaks $50 The Investing Game Could Change

The predominant theme in the markets is the “reflation” trade. For those who have been living in a Scientology compound since November 2016, the reflation narrative goes something like this -> the global economy was improving before the election; Trumponomics (infrastructure spending and tax cuts) will be supportive of a strong economy; asset prices will move higher as the US economy grows at 4%+. BUT…if oil breaks $50, the reflation narrative could fail.

BK has argued that due to the Saudi Aramco IPO, Saudi Arabia has a vested interest in keeping the price of oil high enough to support a strong valuation, but not too high as cause another US shale led supply response. So far the line in the sand appears to be ~$50.

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The Saudi Plan to keep oil prices elevated has worked but is now threatened by market forces. First, the days supply of oil in the US is at a level not seen since the oil bust of the 1980’s (yep, JR Ewing style).

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Second, speculators have not been this long of oil futures since 2006 (green line in the chart below).

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The way the supply/demand fundamentals line up, coupled with market positioning means that if $50 cannot hold then we could see a non-trivial decline in oil. In turn, this would blow a whole in the reflation narrative.