The Wikipedia definition of ‘recession’ is - in economics, a general slowdown in economic activity over a sustained period of time, or a business cycle contraction. India was or rather is hit by recession and one of the reasons it started was the Reliance Power IPO in 2009 which sucked around Rs 11000 crore from the market, though it increased due to the political instability and touched the peak continued with the crash of the three biggest company’s in the US. Of course, there are a number of other reasons too which added to this phenomenon. Though India didn’t suffer from it so “significantly” they claim, but it did affect every individual in some or the other way!

However, post the elections of 2009, some growth and now stability is seen in the economy. These may be attributed to the following factors

1. The growing inflation
2. The rise in Corporate earnings
3. Resurgence of IPO’s

A daily newspaper reported on the 27^th of August 2009 “Inflation rose to -0.95% for week ended August 15 from -1.53% the previous week, according to data released on Wednesday. Analysts expect inflation to touch 7% by March.” The Inflation which is based on the Wholesale Price Index (WPI) rose last week as a result of the increase in prices of food articles. Thus over the next few weeks inflation does seem to be slowly but steadily growing.

There has been a remarkable improvement in the last quarter earnings of companies. The second quarter of this year showed a rise in the corporate earnings. This can be very evidently seen by analyzing reports of a few companies. Patni Computer Systems - Revenues for Q2CY09, at USD 161.9 mn (INR 7.7 bn), were flat and ahead of the guided range of USD 158-159 mn. In constant currency, revenues were up 2.2% Q-o-Q. Revenues for Tata Steel grew to 12% in FY09 and for Chennai Petroleum grew 0.7%.

New Initial Public Offerings (IPO) have started flooding the markets with Adani Power Limited (Rs 300 Crore), Jindal Cotex Limited (Rs 93.40 crore), Raj Oil Mills, Rishabhdev Technocable (Rs 150 crores), NHPC ( Rs 6000 Crore). OIL (Oil India Limited) - Rs 2000 crore is coming up with an IPO soon.

The steady increase in inflation and rise in corporate earnings along with the IPO’s being over subscribed so many times just shows that now companies are regaining investor confidence. The general public is now making sound decisions and investing rationally. The above few points showcase that India as a whole has been able to slowly but steadily recover from the so called “recession”.

In this tumultuous market environment one unfortunate victim among the many vignettes of market wisdom was the “buy-and-hold” strategy. This strategy has worked almost flawlessly and relentlessly for those who stuck to this notion. But this strategy has come under scanner since it has destroyed nearly 50% of assets and wealth for those who continue to stand by it even when markets around the world came down crashing.

This article is not about analyzing this strategy further but to take a serious look at the oil sector where I firmly believe this strategy will work very well for investors who are going to be committed for the long haul. When I say long haul I mean at least 3 years. Black gold has reversed its furious advance in an equally furious manner and I think the elastic is stretched way too far on the short side now. Moreover, as compared to many other sectors such as banking, housing, retail, and even the technology energy sector, the oil sector offers at least some visibility simply because of vast dependence on it.

Here we will take a look at both Light Crude Continuous Contract ($WTIC) and United States Oil Sector Funds ETF (USO) performances but more importantly we will compare that against the S&P500, obviously the most followed barometer of health of the US markets. Any extreme deviation of USO or Oil futures from S&P500 has generally indicated peaks or bottom that resulted in change of direction of prices in oil.

USO

WTIC

Further we will mostly take a technical look at the oil charts coupled with few fundamental thoughts.

First a technical perspective:

Please take a look at $WTIC and USO charts as compared against S&P500.

1. There is no doubt that the severe correction in oil market as indicated by $WTIC chart that plots Light Crude Continuous Contract – smoothening out monthly expiration volatility was mainly due to mid 2008 speculative bubble.

2. I will also use USO (United States Oil Funds ETF) simultaneously to compare some of the facts. USO vs. S&P500 comparison reveals that back in Jan 2007 USO lagged significantly (almost 50%) to S&P500 and that started massive bull market

3. USOs went in overdrive once it crossed S&P500 performance in Jan 2008. I would say that was an inflection point when USO was valued fairly based on the general health of the economy. Then came perma oil bulls and speculators that fueled most outrageous bubble creation in oil that actually traded almost 80% above S&P500 in June 2008 (on closing basis).

4. Since that time in last 6 months USOs (and underlying continuous light crude contract) has had a whopping hair cut of 73% and many people learnt the “the higher you go the harder you fall” lesson the hard way,

5. What is quite interesting now is that in the process of this carnage, it has again come down about 30% below S&P500! What is even more significant is that S&P500 in itself has gone through an amazing crash in the last six months and yet USO trades even 30% below S&P500 levels!

6. Finally, RSI (this is weekly RSI) continues to show improvement over the last two months even when oil hasn’t been rallying much. A very positive diversion indeed.

7. What we need as confirmation and I believe may happen soon is weekly crossover of $WTIC MACD above the red line.

Now let’s discuss some fundamentals:

Although there is a general consensus that along with weaker economies around the world, oil consumption is bound to decline, some basic facts remain intact:

1. Number of vehicles on the road (note that we are not talking about auto sales) across the world have not gone down due to this market crash. As a matter of fact new vehicles are still being added every day albeit with slower rate.

2. The world by no means will detach itself from its dependence on oil no matter how many alternative energy technologies are making inroads to our daily lives.

3. Oil supply is not infinite, that’s a plain simple truth.

4. With gasoline being sold at average $1.5 (from almost $4) in the USA, more people would want to drive (and drive more) than using any other means of transportation.

With this, I think this presents a great opportunity in oil market for investors who would like to be invested for at least 3 years. There is simply very little downside risk than upside opportunity. Downside risk is of about 20-25% as compare to upside opportunity of about 75-100%. Here clearly the strategy should be to be invested in oil with a 3-year time frame in mind but with sell limit order above 75% of the current price. You can even have that order at 100% profit above current price but that purely depends on your risk taking appetite. I opt for this strategy because when a rally starts in the oil market, it is going to fast and furious. Too many oil bashers are going to be scrambling to cover shorts and that will only add to the pace of the rally and in the process your target may be achieved in much shorter time frame than 3 years.

Having said that, I must caution investors that oil will have extremely tough time crossing $79.86 price level and once it starts backtracking from $79.86 price level, it could trade between $50 and $80 for quite some time. These are the thoughts for the long term but let’s focus on immediate and imminent gains that lie ahead of us.

Good trading!