USOIL and recessions

The relationship between crude oil prices and economic recessions is an interesting macroeconomic correlation, where sharp increases in energy costs often act as a precursor to economic downturns. Historically, these rallies have strained consumer spending and increased production costs, eventually leading to a broader contraction. By examining the price action of USOIL in the months and years leading up to previous recessions, recurring patterns can be identified which might be helpful to understand future price action and macroeconomic events.

This analysis explores the historical performance of USOIL prior to several major recessions, the relative strength of oil versus gold, and what these indicators might suggest about the future. While parabolic rallies by USOIL have frequently preceded economic trouble, it remains to be seen how, if and when such a rally will occur again. Even when a rally occurs, it can last for years in prior examples before a recession actually occurs.

USOIL price action before a recession occurs

In the years prior to the Dotcom bubble and the 2008 Financial Crisis, USOIL experienced strong parabolic moves. Before the 2001 recession, USOIL prices rallied by approximately 247%, before falling again during the recession. During the period preceding the financial crisis, USOIL experienced an even stronger rally by approximately 750%.! In both cases, the rapid ascent in energy prices preceded the eventual economic downturn, suggesting that extreme USOIL rallies can be a precursor to recessionary pressures.

Going further back, similar patterns can be observed. Before the recession of the early 90s, USOIL rallied 308%. During the turbulent 1970s, which saw a "triple recession" environment within a decade, USOIL prices rallied by over 1000% which arguably for today's USOIL prices, it seems rather unlikely that it would repeat again, even if such a scenario cannot be fully ruled out. These historical examples reinforce the idea that USOIL often "blows off" to the upside before the economy finally loses under the pressure of such high oil prices.

However, not every recession is preceded by an USOIL rally. The 2020 pandemic-induced recession stands as a clear exception. Leading up to 2020, USOIL had been trending downward within a well-defined bearish channel. There was no speculative blow-off top. Instead, USOIL prices collapsed temporarily under the pandemic-induced recession. While USOIL rallies are common precursors in the last few decades, they are not a requirement for a recession to occur.

When comparing USOIL to GOLD, the ratio is currently testing significant historical support levels. The RSI for the USOIL/GOLD ratio is showing signs of bottoming, which could indicate that USOIL is becoming "cheap" relative to gold. However, technical analysis suggests that a further breakdown cannot be entirely ruled out, as the ratio has reached even lower levels in the past. A bounce here would suggest USOIL outperforming gold, possibly signaling the start of a pre-recession rally. Keep in mind that even when a rally by USOIL occurs, they can last for years in some cases before a recession actually materializes.

Conclusion

The historical data suggests that USOIL often undergoes a significant price expansion before the onset of a recession. From the 300% gains in the 90s to the massive 1000%+ moves in the 70s, USOIL has frequently been a "canary in the coal mine" for economic trouble.

Currently, USOIL lacks the massive parabolic rally seen before most historical recessions, behaving more similarly to the pre-2020 period than the pre-2008 period. However, with the USOIL/GOLD ratio sitting at long-term support, the potential for a significant move is high. Whether that move is a rally that eventually triggers a recession or a breakdown that signals deeper economic weakness remains to be seen. Traders should watch for a decisive break in the USOIL/GOLD ratio to gauge the next major macro trend.

Pitfalls

Keep in mind that this is a dubious speculation that may or may not occur. USOIL might be more bullish than the analysis of the article or more bearish depending on how market sentiment evolves in the future. Indicators do not tell the future with absolute certainty. They are useful to reason about the future, and it is important to balance both bullish and bearish scenarios to avoid bias as best as possible. Lastly, all indicators are prone to failure every now and then. They tend to work well for a while, but eventually, some indicators fail, while others do not at a given time. As more data comes in, the analysis will evolve to incorporate new moves, invalidate a previous hypothesis or gain evidence for a previous idea.

In this analysis, we looked at the USOIL/GOLD ratio. While this is helpful to understand how an individual asset performs against something else, the interpretation of USOIL/GOLD allows for multiple scenarios to occur. Since GOLD and GOLD are moving too, it influences the final outcome of USOIL itself and the path it takes.

For an approximately constant GOLD price, USOIL/GOLD could go lower, because USOIL is underperforming GOLD (dropping). If USOIL/GOLD goes higher, then USOIL is outperforming GOLD by going higher more quickly and thus, a good selling opportunity might present itself in the future. Such relative comparisons are tricky at times, and it is important to keep in mind that its interpretation could be more ambiguous.