In view of the approaching 8-year cycle bottom we've been discussing in recent articles let's examine the crude oil market compared to previous cycles for ideas on what to expect in the weeks and months ahead.

Does oil follow the 8-year cycle as closely as the stock market does? Not as closely but the longer-term cycles with the Kress 120-year cycle series typically have a depressing effect on the oil price, not before but just after the final bottoming phase of the cycle. In other words, the oil price usually has a delayed reaction to the longer-term cycle bottoms.

For instance, the last long-term cycle bottom that we experienced this decade was the 12-year cycle bottom of October 2002. We all remember how bad the year 2002 was for stock prices as the bear market that had begun in 2000 was at its worst. Stock prices fell nine of out of 12 months in 2002 before bottoming in the fall of the year with the 12-year cycle low. During most of 2002 the oil price was actually rising off its late 2001 low price of approximately $17/barrel and made a high of just over $30/barrel in the fall of 2002 just as the 12-year cycle was bottoming. In the weeks immediately following the 12-year cycle bottom, the oil price experienced a rather sharp retracement or corrective pullback from about $31 down to about $25 (at that time a fairly sizeable decline). After finding support above the $25 level, oil continued its bull market into 2003.

What is the relationship between the 8-year cycle bottom and the price of oil? As discussed in the previous commentary entitled "A look at the upcoming 8-year cycle bottom," the previous 8-year bottom in autumn of 1998 saw an almost across-the-board bottom of what had been a severe decline in stocks and commodities that summer. The crude oil price had fallen from its high in January of that year to a low of around $10/barrel by the end of the year, making it one of the last to bottom among the fuels (natural gas bottomed in September-October along with the orthodox low of the 8-year cycle in '98 along with the broad stock market).

Despite the belated bottom in oil in 1998 you can see that there was downward pressure being exerted against the oil price throughout that year in response to the falling 8-year cycle. The slope of the oil price through 2006 has been upward, but even this year with the 8-year cycle bottoming you can see evidence that there is pressure against oil coming from this cycle. This has especially been evidence since late April/early May of this year as oil peaked at that time just over $74 and has been below that level since.

What this testifies to is that the secular trend for oil is up while the short-term trend is coming under pressure from the "hard down" phase of the latest 8-year cycle that is due to bottom in September. Once the downward pressure from the 8-year cycle has lifted oil should eventually resume its upward bias with 2007 most like witnessing a rising trend. One reason for this assumption is that the 8-year cycle is really only a composite of the 2-year cycle. The 2-year cycle bottoms in even numbered years and peaks in odd numbered years. In response to the 2-year cycle you can see that the oil price tends to outperform in odd years (1985, 1987, 1989, 1999, 2005) and underperform in even years (1984, 1986, 1988, 1992, 1998).

One very notable exception to this was in 1990 when a previous 8-year cycle was bottoming. The oil price experienced a rather sharp drop from February through July of that year when downward pressure from the 8-year cycle was strong. That summer, however, the oil price made an about face and shot up to a major high at that time of $40/barrel. This was in the face of the Persian Gulf war of course and is an example of how political considerations can supercede strictly financial concerns in the oil market due to its extremely sensitive nature. Yet in keeping with the delayed reaction it often has to a longer-term cycle, the oil price declined sharply in the months following the bottom of the 8-year cycle in 1990, with oil dropping from $40 to a more subdued $18/barrel in early 1991.

With the secular trend of oil up relative to the comparable period in the previous decade, the upcoming 8-year cycle bottom should produce for oil a meaningful pullback followed by a resumption of the rising trend probably by sometime in early 2007. The previous 8-year cycle low in late '98 was followed by an explosive rally in the oil price from early 1999 until later 2000 with oil rising from $10 to almost $40 in that nearly 2-year period. At that time oil was coming off a major "oversold" extreme so it's doubtful the rise in oil following the upcoming 8-year cycle low will be as pronounced. There should, however, be a distinctive if asymptotic upward move in oil from roughly 2007-2009.

This expectation is not only a function of the market being relieved of downward pressure from the 8-year cycle; it's also a natural response to the tendency of inflationary commodities such as oil and gas to experience bull markets during the final three years of any given decade. This decennial pattern is not a cycle, properly speaking, but rather a recurring pattern within a longer-term cycle. Looking back at the past several decades you can see the tendency for stagflation, or the phenomenon of stagnant earnings growth and rising commodity prices, to rear its unsightly head from approximately the seventh year of the decade through the ninth year (e.g., 1977-1979, etc.) During this period stock prices often experience meaningful gains despite the fact that corporate earnings growth begins to slow noticeably, partly in response to rising commodity prices. This in turn eventually gives way to the bear market and/or economic recession that usually accompanies the onset of a new decade.

The upcoming 2007-2009 period will probably not be an exception to this historic pattern. Stock prices will likely benefit from the lifting of the 8-year cycle pressure in 2007 up until the peak in the 10-year cycle in 2009. But during this period we can also expect to see certain commodity prices pushing forward with stocks, gradually undermining corporate balance sheets along the way. The years 2007-2009 will be a transitional time for the U.S. for it will represent the final forward surge before the massive deflation beginning with the bottoming of the 60-year/120-year cycle in 2010-2014.