Trend Reversal in Oil

I have been very bearish on oil for quite some time now but this week has brought about a trend reversal on many different time frames. Before I go into my analysis I think it’s important to consider this trade without any bias as to where you think the price of oil is heading. Essentially it makes no different where we think oil is heading. Think about it. Nobody ever thought oil was going to go to $150 a barrel that fast, but it did. And when it collapsed to it’s present level, everybody (including myself) doubted it the entire way down thinking it would rebound quickly and make new highs.

Therefore I’m merely pointing out that our opinion on where oil should trade at inhibits our ability to trade in the moment. Below is a weekly chart of $WTIC with a chart of the Dow imposed behind it. It’s important to note the times when they trade inverse each other and when they trade in tandem. March-August of last year Oil really took off as the Dow was cratering and then they began to trade in unison again after than. Now we are beginning to see Oil take on more of a leadership role as the Dow flounders. It will be important to observe this trend and see if it develops into more of a substantial trend, thus confirming my bullish bias.

Also notice the strength in the RSI and Stochastics as they move 2 steps forward and 1 step back in an upward fashion. While a break out of this triangle formation will be confirmation, I think enough bullish signs are present that a move up is inevitable despite whatever the overall markets do. Oil is acting like it is finished moving lower which is bad for the overall markets.

When you look at a shorter time frame you see the bullish realignment of the moving averages. Notice how it bounced off support at the 38.2% retracement level, displaying bullish behavior. If oil starts to fail, you will see it first in this chart, but personally I think we’re heading higher.

Comments

[john s. gordon:]

don't forget the 147/bbl oil was caused by speculation by speculators & hedge funds using borrowed money at 33/1 leverage. in today's situation of no borrowable money anywhere, are we likely to have a recurrence?
> jack

Mar 01 09:29 AM

[ShamusJ:]

Interesting article, but I always take technical buy/sell indicators with a pinch of salt. If I didn't, then according to the Relative Strength Indicator I would have sold oil in Oct 2007, and then cried myself to sleep every night as I watched it's relentless rise to $147. The problem with using technical analysis on oil trading is that it is one of the most unpredicitable short term instruments on the market. Having said all of that, I do share your bullish view on Oil, but only because of the vast amounts of data that I have sifted through on likely future supply/demand, as well as general OPEC sentimentality. I've also factored in non-OPEC production growth in the next few years as being lower than predicted due to the low price of oil. I do not regard RSI as useless, and I usually only consult it at the end after forming my judgements from news/politics/data, in order to see if my buy/sell opinion is supported by it.

Mar 01 09:57 AM

[ETF STER:]

Looking at the first chart, you can see a wedge formation, if oil breaks below that wedge...look out below.

Oil is oversupplied right now, and yes, there will be a time in the future (who knows how far in the future) when oil will be in shorter supply, however, inventory is still building and demand is flat or falling.

I believe there will be a breakout lower from the wedge formation................
but hey, that's just my opinion.

RJ

Mar 01 10:16 AM

[Jonathan Ch...:]

I'm no oil expert, but this is the way I look at the situation. I do not include any numbers in this note, but these statements are supportable (except, perhaps my opinions about currency price movements)

During the spike in oil prices, OPEC and other oil producers were unable to control oil prices because production was maxed out. OPEC was unhappy at the loss of control, and began plans to increase production.

As the world economy started to slow, current and projected demand dropped below production capacity. Speculators, who deal with prices at the margin, lost control as producers met and then exceeded demand, and prices plummeted. However oil producers began to shelve their more expensive projects due to lower prices.

For the next several quarters oil capacity will exceed demand by a margin sufficient to maintain OPEC control, at prices I would guess lie in the range 40 to 60 dollars per barrel, at current dollar values. However there are several interesting dynamics.

First is that the oil we purchase is produced in other currencies. Some of these currencies, perhaps the Russian Ruble, the Venezuelan Peso, and the Mexican Peso will decrease in value. Other countries, such as Brazil, Nigeria, and Indonesia may see a rise in the value of their currency. Because of the high inflation potential of huge US budget deficits, the tendency to buy Dollars for safety will be countered by the certainty of future inflation. These factors should increase oil volatility.

Countering the currency-induced volatility is the actual decline taking place in several producing areas. Total oil production in the US, Mexico, North Sea and Russia continue to decrease. The amount of new production coming on line at present prices is very low and do not equal the decline. The net result is decreasing net oil, at a time when underlying demand is increasing. By "underlying demand" I mean the likely demand with the world in constant or increasing GDP.

While there is interest in renewable energy resources, the current low price of oil will shut down most existing projects.

The end result is increasing pressure on oil prices, even with a global recession, and the potential for much higher oil price spikes in the future.

Mar 01 10:26 AM

[Ferdinand E...:]

When the price of oil reached $147/b, the Swedish crown dollar rate was about 7 to 1, and now it's 9 to 1. What does this mean, well for one thing the Russians who like to pay a couple of hundred dollars for a bottle of champagne can drink their champagne and do their skiing in the Midnight Sun in Sweden instead of Courchevel (in France). And not just the Russians. The present rise in the value of the dollar relative to some currencies must be wish fulfillment for the oil producers.

And by the way John, speculators and hedge funds were NOT responsible for the escalation in oil price, although they might have been responsible for some of it. If anyone believes otherwise, they are going to be very lonely in those elite seminars where movers and shakers do their song and dance.

Mar 01 11:41 AM

[ROLEXROLEX:]

Nobody made a dollar (1$) consistently looking at technicals only, but many lost everything trading on it, didn't CL looked good at 147$?

Mar 01 11:47 AM

[Grampa Jim:]

>>speculators and hedge funds were NOT responsible for the escalation in oil price, although they might have been responsible for some of it.<<

Nonsense. I believe they were responsible for MOST of it, the CFTC report notwithstanding.

Mar 01 12:36 PM

[Grampa Jim:]

Furthermore, WSJ, 2-28/3-1-09, pB6: Regulators Probe Oil Trading - Aim is to Rein In What They See as Excessive Speculation. "A probe of how US Oil Fund LP (USO) and others conducted themselves during a key trading period marks a renewed attempt by commodities regulators to rein in what they view as excessive speculation in the oil markets. ..."

Mar 01 01:08 PM

[silver-bug:]

Great charts. In response to Granpa Jim, the CFTC is barking up the wrong tree, again in regards to excessive speculation. There are many culprits in the oil price manipulation scheme, and it goes both ways. I think the US gov. has a big hand to play in the oil prices going down... here's an article on US gov. Oil Swaps where they swap higher quality oil for lower quality cheaper oil, and selling the higher quality oil and flooding the market.. news.goldseek.com/Gold...

Mar 01 01:29 PM

[Jeff Pierce:]

After reading these great comments and having read still many bearish articles on the blogosphere almost give me more reason to be bullish on oil (at least for the short term). So many people think oil is going to drop further that one may be able to use that as a contrarian indicator in itself.

Mar 01 02:10 PM

[Alphameister:]

Good article, Jeff. Might turn out to be a relatively minor advance, but every major advance begins with charts similar to those you've presented.

Mar 01 02:57 PM

[ASB:]

There are a lot of comments about oil directions - some of them bullish and other ones are bearish. But please share your opinions about how we can play that trends. Let assume it will go upside in short term. What are the possibilities?
USO ?
Maybe day trading only, or swing trades lasting one-two days ?
Having in mind how that ETF is constructed it is naturally the best short at the market today.
Please share your opinion over potential plays - both bullish and bearish.

Mar 01 03:30 PM

[BrotherMaynard:]

This is the fourth month in a row that oil is doing its head-fake. CL front month is caught in a feedback loop. The lack of storage capacity is at the heart of it. As expiry rolls around the front month contract sells off as nobody can take delivery (Cushing is full). The next month contracts get bought up on the roll and pop back to the fourties. Oil can't go any higher, otherwise everybody that has been storing oil will dump it, pushing prices back down. Its going to take a genuine demand upturn to eliminate the massive overhang of excess oil and break this loop (alternatively, the CFTC could actually enforce position limits on the USO wich holds some 60k contracts...the main offendor when it comes to distorting the roll)

Mar 01 04:01 PM

[Hmm?!:]

BrotherMaynard,

Are you referring to contract rollovers?

That would make sense to me since producers could keep selling the forward months and continually collect a higher than market price. This could also maintain a higher than needed production rate.

Hence, there may be some slow moving tankers out at sea right now.


On Mar 01 04:01 PM BrotherMaynard wrote:

> This is the fourth month in a row that oil is doing its head-fake.
> CL front month is caught in a feedback loop. The lack of storage
> capacity is at the heart of it. As expiry rolls around the front
> month contract sells off as nobody can take delivery (Cushing is
> full). The next month contracts get bought up on the roll and pop
> back to the fourties. Oil can't go any higher, otherwise everybody
> that has been storing oil will dump it, pushing prices back down.
> Its going to take a genuine demand upturn to eliminate the massive
> overhang of excess oil and break this loop (alternatively, the CFTC
> could actually enforce position limits on the USO wich holds some
> 60k contracts...the main offendor when it comes to distorting the
> roll)

Mar 01 04:27 PM

[SeekingTruth:]

I am a basically neutral observer on the price of oil short term with perhaps a slight very short term bearish bias with volatility until just before oil production cuts start to kick in.

However, I would like for some of the oil experts out there try to explain the "difference" between oil in storage (inventories) being held for contractual future delivery, and the amount of oil held in storage because there is not enough immediate demand for it, and has no firm contract on it.
There must be some kind of ratio (or difference) for this , but I am not sure if it is possible to access this kind of information.

Does anyone know? Thanks to anyone ready and willing to help.

Mar 01 07:06 PM

[January Thaw:]

It may go higher for awhile, but without the market to support it, can it
keep going higher???

Mar 01 10:30 PM

[chirs$wallst:]

awesome charts jeff

Mar 02 07:18 AM

[Smartest Oi...:]

Oil going to $25.

Mar 02 11:39 AM

[Vortex Solar:]

Forget it ! It has further to go down, in my opinion. There is too much stored oil that would start flowing back into the market as the storage becomes more and more expensive. Unless, there is an extraordinary event, causing supply fear, or demand boost oil is going down at least in the short term.
Otherwise, I am bullish on oil in the long term. If we are to believe that the crisis will end and the world will look similar to what it is today, then we should belive that oil will go up again. It will never go up as high as it it did last year, becouse of investment in alternative energy, but it is going to go back up substentially.

Mar 04 12:24 AM