Why The Saudi Oil Attack Is The Biggest Story To Watch This Week…

This week, the most important image isn’t a chart of the stock market…

It’s a pair of pictures telling a fast-paced story about oil prices.

The first is a daily chart of oil futures. The second of the pair is a satellite image of thick black smoke rising from Saudi Aramco’s Abqaiq oil processing facility – that explains the price jump at the far right of the futures chart.

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Here’s the first chart.

And here’s the second.

You may have seen this image over the weekend. Initial reports indicated Yemen’s Houthi rebels launched drone attacks on the facility, resulting in about half of Saudi’s processing capacity being taken offline.

I have a third picture to show you – one that highlights just how significant this all is. As the graphic illustrates, this blow to Saudi’s processing capacity is the biggest supply shock in history. It accounts for about 5% of the world’s daily supply of oil.

[A Quick Note: I want to point out that the chart above is produced by the Associated Press. There is a small typo about halfway down the graphic that reads “Invation of Kuwait.” That should read “invasion,” and Kuwait certainly did not invite the Iraqi Army to seize its oilfields. I want to highlight that the typo is the AP’s.]

Engineers are working to overcome the losses. For now, Saudi Arabia is optimistic, at least according to news reports.

The question, for now, is whether this attack was the escalation of a war. If it was, we should expect a major decline in stocks. But all the bad news is offset by a shift toward bullish sentiment.

Changes in sentiment are a process. They tend to occur over a period of weeks to months – not just days.

It All Goes Back To Sentiment
As I’ve been highlighting over the past few weeks, sentiment has recently reached a bearish extreme.

I’ve been focusing on the American Association of Individual Investors (AAII). As I note each week, the average readings we’d expect to see are 38% bullish investors, 30% bearish investors, and 32% neutral investors.

On August 8, only 21.7% of individual investors were bullish, almost 49% were bearish, and about 30% were neutral. But things are changing. This week, a third of investors are bullish.

Source: AAII.com

Now, compared to readings we’d see in an average week, the number of bulls still remains unusually low. But sentiment is shifting – or, at least, it was. Like I said, shifts in sentiment are a process that can take weeks or months to unfold. But as they do, a price trend develops.

Right now, there is more than $3 trillion in money market funds. That mountain of cash will drive the next uptrend. We know this because we can look at how the S&P 500 has performed compared to our weekly sentiment check-in. As the chart below shows, the index has gained almost 4% as investors moved from extreme bearishness in early August to our current state of “mild” bearishness.

The risk is that news from the Middle East could lead to an increased fear of war – and a reversal in sentiment. Even if war fears subside, there is a chance Saudi Arabia will not be able to quickly repair the damage.

According to The Wall Street Journal

Saudi Arabia held a series of calls with cartel members and other oil-producing allies over the weekend and told producers that they wouldn’t need to respond with additional output, Saudi and OPEC officials said.

Saudi energy officials fear that other members might begin pumping too much and take away some of the kingdom’s market share, Saudi oil officials and advisers said. Saudi officials told cartel members that the kingdom would mitigate the outage by tapping into its reserves, the Saudi and OPEC officials said.

The United States is also acting to relieve stress in the markets. President Trump tweeted that he’s authorized releasing oil from the Strategic Petroleum Reserve (SPR). The amount of oil released will be ‘sufficient to keep the markets well-supplied.’

The Strategic Petroleum Reserve holds 630 million barrels. It was set up after the Arab-Israeli War in 1973, and was last tapped in 2011 in response to the Libyan Civil War.

News reports indicate that countries around the world are doing all they can. Yet, as I type this, crude oil prices are up more than 14%. That indicates the markets expect a problem… one that will likely not be easily solved by releasing reserves.

Action To Take
This is the biggest story for traders to watch this week. I’ll update you next week with how the initial attack affected stocks in the longer run. My initial analysis is bearish, but we need a couple more days of data to assess whether it is bearish for days… or months.

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