By Barani Krishnan

Investing.com: How to tell when excessive exuberance leads to asset increases that are too high, and then cause unexpected and long-lasting contractions.

It’s a question the late Federal Reserve legend Alan Greenspan raised in a landmark 1996 speech, just as the era’s dotcom bubble was starting to froth.

It remains unanswered. James Dorn, Cato Institute, reflected on this in a recent blogThe Fed is racing to end the Covid-triggered bond/mortgage purchase it began 2 years ago, and start a higher interest rate regime. This could potentially last until 2024.

“What jumps out from Greenspan’s speech is how he posed a problem that the Fed never solved, and then made things worse,” observed Dorn. He cited the “Greenspan put” that had since become the Fed’s practice, as the central bank sought to manage one economic crisis after another with rate adjustments that never deflated the stock market itself.

The Fed failed to achieve the desired inflation in its attempt to protect stocks, or at least avoid being blamed for them falling. It missed its annual goal of 2% for a decade prior to the pandemic. It is now exceeding its annual target of 2%, growing at 7% per year in December, the fastest pace in over 40 years.

Inflation is the highest level in seven years for oil prices. It rose as high as 6% in the week just ended, following gains of approximately 11% over three weeks. U.S. crude has risen 12% and global benchmark Brent is rising 11% for 2022.

Oil’s rally was caused by years of low investment in exploration and production. The impact of this is now, two years after the outbreak. The shortage of new oil is not the only problem. OPEC+, the producer alliance continues to keep the market from an estimated four billion barrels daily due to cuts of around 10 million barrels each day made during the peak of Covid-triggered destruction of demand. U.S. output, once the world’s largest with a pre-pandemic high of 13.1 million barrels daily, is now at under 12 million, thanks to unfriendly drilling policies of the Biden administration which wants renewable, green energy over fossils.

Last but not the least, oil prices have risen 60% in the past year due to the investment dollars being poured into crude oil for inflation hedge.

And that’s where some of the irrational exuberance of investors sit. Wall Street banks cheering hoarsely as they bid $90-$100 for oil, so oil longs have entered the race to raise crude prices as high as possible as a way of protecting themselves against inflation.

While the fundamentals of the oil rally are strong, gains over the past weeks seem frothy. If you’re long oil and foaming at the mouth as you read this – a sign of irrationality, no doubt – read on because this observation also comes from people who are typically bullish on crude.

“The rally in oil yesterday and today came on no-news and that’s evidence of a squeeze on positioning,” Adam Button of ForexLive wrote in a Jan. 12 post after U.S. crude prices jumped 5.5% over a 48-hour period. Anyone who reads Button regularly will know he’s as ardent an oil bull as one could be. In that post, he reasoned that macro shorts in oil may be throwing in the towel as longs piled into the trade amid data suggesting that Covid’s Omicron may just have a fleeting impact on crude, regardless of the fears being built around the variant.

Button also worried about fuel demand. After the U.S. Energy Information Administration had reported that gasoline demand rose by 7.96million barrels during the week just before, exceeding forecasts of a 2.41 million increase. The latest build added to the previous week’s rise of 10.13-million barrels, which was already the largest weekly surge in gasoline stocks since the height of the coronavirus crisis in April 2020. EIA data showed that overall gasoline inventories increased by almost 30,000,000 barrels in the last six weeks.

The inventories of distillate, which is used to make diesel for cars, trucks and buses as well as jet fuel, grew more than anticipated for the second week. They climbed by 2.54 million barrels, compared with 1.76 million. Distillate stocks increased by 4.42 Million barrels in the week before.

Fair enough, crude oil prices also fell, with 4.6 million more barrels dropping than the previous week’s drop of 2.1million. However, the total crude oil stockpiles decreased by 23 million barrels in the last six weeks. This was in spite of the increase in gasoline and distillates.

As winter slowed down driving, the demand for gasoline fell. Employers are delaying plans to return workers into their offices due to an increase in Omicron cases, regardless of whether they are dying from it. This will reduce commuting as well as other transportation that requires fuel.

“Ultimately, this optimism will need to be reflected in demand,” Button wrote, referring to the optimism among the long-oil crowd pushing for $90-$100 oil.

Add a button:

“What I worry about is a sustained drop in Chinese demand due to Omicron. While most of the world is now able to continue with the virus, more than 20,000,000 people are locked up in China right now. I expect that number to grow in the coming weeks and that’s something that could severely hurt physical demand.”

“From where I stand, that’s enough reason to sell oil and return to the sidelines near $85 in WTI.”

Button published another post two more days later.

“The next step for oil will be a tough one,” he said in the follow-up. “A report today highlighted that China had agreed to release strategic oil reserves in different levels around Feb 1 depending on whether crude was at $75 or $85. With Brent at $86 and also mere cents away from the October high, the odds of more action rise.”

“At the same time, SPR releases are small amounts of oil overall,” Button said, referring to the Strategic Petroleum Reserves from both China and the United States that will start hitting the market over the next few weeks. “What we’re seeing in jet fuel demand destruction and less driving should far outweigh that – yet it isn’t. The market has pushed through the huge increases in U.S. gasoline supply. The buying is relentless.”

Phil Flynn, another avowed oil bull who’s energy analyst at Chicago’s Price Futures Group, also cited in a January note that China will soon release an unspecified amount of oil into the market depending on price levels.

Flynn stated, citing a Reuters article, that China had agreed to release a greater amount if oil prices rise above $85 a bar and a lesser volume if oil remains at $75. According to Flynn, the Chinese will release their crude oil stocks around the Lunar New Year. China will observe its largest annual holiday from January 31 through February 6.

Flynn made mention of China’s 2021 crude oil imports. These numbers were the lowest since 2001. Beijing has been tightening its grip on the refining industry to cut excess domestic fuel production and refiners have reduced huge inventories. China, which has been driving global oil demand for the past decade, accounts for 44% growth in world oil imports from 2015 to 2015. Beijing issued import quotas for independent refiners.

Button and Flynn will not be turning into oil bears due to the compromise they tried to achieve in their comments. In recognition of some the immediate market problems facing oil longs and especially China’s growing determination to combat oil price inflation, they did this. It’s called rational thinking – something that’s needed in oil now.

Crude Price & Technical Outlook

, the benchmark for U.S. crude, settled Friday’s trade at $83.82 a barrel, up 2.1% on the day and 6.2% on the week.

The London-traded oil benchmark was at $86.06, an increase of 1.9% and 5.3% respectively.

Sunil Kumar Dixit (technical strategist at skcharting.com) said the prevailing bullish trend in oil could propel WTI to $86.50 then, subsequently to $90.30 if price levels remain stable above 84.

“The weekly stochastic reading of 92/78 remains strong in favor of a further up move in U.S. crude,” said Dixit.

However, he cautioned that prices could lose their upward momentum and fall below $82.74. He said this was likely to happen if there is a shift in the oil narrative due to the U.S. stockpiles data being more bearish or SPR release impact.

“A daily close below $82.74 will expose WTI to $79.50 while a weekly close below this level is likely to trigger a correction to rebalance the parabolic rise in prices to $77.50 and the $75 areas,” he added.

Roundup of Gold Market Activity

Gold had another high-wire balancing act, ending Friday’s trade down but the week higher.

More importantly, it recaptured the $1,800 level before the week’s close – a phenomenon broken only once in every weekly close of gold since the start of December.

Gold’s mixed close occurred during a week in which the yellow metal was trapped between two U.S. data sets – the Consumer Price Index (CPI) and the retail sales.

After Wednesday’s CPI report, gold rose 0.5%. It showed that U.S. Inflation rose 7% from the year prior to December 1982, making it the fastest increase since 1982.

But on Friday, the price dropped 0.3% after both the and yields on the crept higher as plummeted on consumers’ concerns about inflation – reinforcing the need for urgent rate hikes.

“Gold seems like it is in a good place as Treasury yields won’t be rallying much higher until at least a couple more Fed meetings” when the central bank announces its first pandemic-era interest rate hike, said Ed Moya, analyst at online trading platform OANDA.

After the March 2020 outbreak of coronavirus, the Fed cut interest rates almost to zero. They remained at zero-0.25% for the past two years. The central bank’s officials have signaled that as many as four to five rate hikes may occur over the next year, with the first likely coming as early as March.

In 2020, the U.S. economy contracted by 3.5% due to disruptions and shutdowns caused by Covid-19. For 2021, the Fed projects a growth rate of 5.5% and for 2022 it will be 4%. The central bank’s problem though is inflation, running at four-decade highs as prices of almost everything have soared from the lows of the pandemic due to higher wage demands and supply chain disruptions.

Since the beginning of 2022, gold has held at the $1800 mark. This is Gold’s inflation hedge. Last year, gold failed to fulfill its hedge mission as both the U.S. Treasury yields and the dollar rallied on fears of U.S. rate increases.

Gold is almost always affected by news of rate increases. This was evident last year when it fell 3.6% to close 2021, its first annual decline in three years. Its sharpest slump since 2015!

But analysts think that if the U.S. inflation theme remains strong through 2022, then gold could even retrace 2020’s record highs above $2,100 – a peak which, incidentally, came on the back of worries about price pressures as the United States began spending trillions of dollars on pandemic relief.

Gold Price & Technical Outlook

Gold futures’ most active contract on New York’s Comex, , settled Friday’s trade down $4.90, or 0.3%, $1,816.50.

It rose by 1.1% for the week.

According to Dixit, skcharting.com, gold prices showed a resolve to resist bearish pressures during the week. A test at $1,782 helped yellow metal recover to the $1.830 resistance.

“While the rebound to $1,829 from $1,782 lows and weekly close at $1,817 does indicate bullish determination, failure to clear the decisive supply zone of $1830-$1835 casts a shadow of uncertainty,” Dixit said. “This raises the possibility of further downside, should the Dollar Index strengthen above the 95.25-95.55 levels and toward 95.85, fuelled by rising Treasury yields.”

He said the coming week’s outlook was mixed with more volatility foreseen.

Dixit indicated that major movements will be dependent on how traders react to $1,825, which is a 38.2% Fibonacci Level.

“Consolidation above $1,825 will indicate further upside to test the $1,830-35 level required for the next leg higher at $1,860 (23.6% fibonacci level).”

“Weakness below $1,825 will start a correction to the 5-week Exponential Moving Average of $1,820 and the 10-week EMA of $1,806 extending to the weekly middle Bollinger Band of $1,795.”

Disclaimer:Barani Krishnan is not a shareholder in any of the securities or commodities he writes about.