Exclusive Gasoline-Price Insight: Too Many Bulls?

Economic outlook trumps volatility at the pump: Zimmermann

NEW YORK -- In the world of supply and demand, there is nothing that is quite as effective in dampening price volatility as a surplus. When it comes to gasoline prices, end users are concerned when prices spike higher. Conversely, falling prices are celebrated.

Walter Zimmermann

Rising and falling prices are two sides of one coin, however, and that coin is volatility. When there is a surplus, prices cannot spike as high as when supplies are tight. And when prices rise at a more muted pace, prices also fall at a more muted pace.

Gasoline prices lapsed into a trading range back in 2011. And prices have been range-bound since. It started off as a rather wide swinging trading range; however, the pattern since 2011 has been a series of lower highs and higher lows.

The trading range has been shrinking. Volatility has been in a downtrend. Who or what is shrinking the gasoline market price range? Such an outcome could not have been possible if supplies were tight and demand were strong. But before we get into actual supply and demand, I want to touch on sentiment.

Market sentiment refers to whether people are bullish or bearish. I use the Market Vane service; it started tracking gasoline sentiment back in 1983. Over the years, gasoline would typically become an overpriced sell opportunity whenever sentiment was higher than 70% bulls. And gasoline would typically be an underpriced buy whenever there were less than 30% bulls. Gasoline sentiment would tend to bottom near 40% bulls into November/December as prices were carving out their seasonal cycle low. And sentiment would typically peak above 70% into April/May as gasoline was forming its seasonal peak; however, gasoline sentiment has not spent any appreciable time below 50% bulls since 2010.

Since 2010, each succeeding major low in gasoline prices has had a more bullish sentiment reading. And each next major high has had a more bullish reading. So even though prices have been in a shrinking trading range since 2011 and volatility has been in a downtrend, bullish sentiment has been in an uptrend.

Is this increasingly bullish outlook for higher gasoline prices justified? What does the supply-and-demand picture say?

Regarding demand, adjusted for population size, estimated total miles driven in the USA peaked back in June 2005 and is since down 9% to pre-1995 levels, according to the federal Department of Transportation. This is an unprecedented drop. Not adjusted for population, total miles driven still peaked back in 2007, then fell almost 4% by mid-2009. And despite the so-called economic recovery, total miles driven is still down almost 3% from the November 2007 peak. This too is unprecedented.

What about supply? Based on Department of Energy data from 2001 total gasoline stocks have been redefining the high end from 2010. Since the trading range in gasoline prices began to unfold from 2011, there has been an unrelenting and historic excess of gasoline supplies. And since 2007, gasoline implied demand has been falling with 2012 and especially 2013 redefining the low end of the historical range. As would be expected in this situation, total gasoline imports have never been lower. So the increasingly bullish outlook for gasoline prices cannot be a function of actual supply and demand. It must be arising from an increasingly bullish outlook for the economy.

So the big question is whether a bullish economic outlook is justified. When we look to sentiment for the S&P 500 and Nasdaq 100 indices, we find bullish sentiment levels that have only been previously seen at major bubble peaks. My technical analysis of both stock market indices strongly suggests that they are much closer to a bursting bubble than a buying opportunity. Stock market sentiment is definitely at a bullish extreme. What about the underlying economic data? My No. 1 most-important piece of economic data is inflation-adjusted median household income. Those numbers are still lousy.

What is the bottom line? Those bullish on gasoline prices are actually bullish on the economy. Those bullish on the economy are looking at the stock market. The critical indicators of real economic performance do not justify the stock market's excessive bullish sentiment. So gasoline bulls appear headed for a big disappointment.

Walter Zimmermann is chief technical analyst at United ICAP. He publishes monthly, weekly and daily energy and financial market price forecasts by subscription. Walter can be reached through walterz@united-icap.com.

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