Seeking Alpha
Profile| Send Message|
( followers)  

With all of the hoopla surrounding the recent rally in crude oil prices, such as the excitement and bullish implications of spot crude hitting its highest price in three weeks, it is time for a bit of a reality check. With the US economy in continuing decline as evidenced by moribund housing and employment numbers, there is little reason to be a perma bull based on US demand. Those that insist on taking the bullish slant look to China as the godfather of consumption, but cracks are beginning to show in China's economic situation. Besides - does the Shanghai Composite (down 22% for the year) have the look of a world economic leader? Weakness in the Shanghai Composite has been evident since its August 2009 top:

(Click to enlarge)

Next let's have a look at one of my favorite charts that shows the performance of XLE versus the S&P 500. Many equity traders use energy stocks as proxies for the crude oil market. If the price of crude is expected to rise, traders buy the stocks of companies who would benefit most from the rise (energy companies). The same is true of gold and gold stocks.

When the black line is rising, energy stocks are outperforming the S&P 500. When the black line is falling, energy stocks are underperforming the S&P 500. The red dashed line plotted on the chart is the price of West Texas Intermediate Crude Oil. Notice the very strong correlation between the two lines from 2005 to the 2008 top. During the 2008 meltdown there was an obvious disconnect as all financial markets were rattled to the core. The correlation reasserted itself in the spring of 2009, but so far in 2010 there has been a troubling divergence as the XLE; SPY spread has headed south while crude oil prices continue to levitate. If a rally in crude oil were brewing, there would not be net outflows in energy stocks versus the broader equity market.

(Click to enlarge)

Next let's have a technical look at crude oil prices along with volume. I find it amazing that so many pundits make predictions in the crude oil market or any other market for that matter with incomplete information. Volume is the piece of the analysis puzzle that shows the amount of conviction behind rallies or selloffs. Price advances on declining volume (low conviction) usually turn out to be corrective bounces and nothing more. Notice the bearish volume pattern in the daily chart of the continuous crude oil futures contract below.

(Click to enlarge)

Notice also how the common Fibonacci 61.8% retracement level is providing resistance as crude has stalled at that point following the low volume rally off of the May low.

Finally, let's have a look at the weekly chart which further confirms the bearish volume and also gives us a much clearer look at price action which allows for a simple A-B-C pattern price projection. The principle of market symmetry governs the use of A-B-C projections in that the length of the A and C legs will be very similar. The distance of the A leg is subtracted from the top of the B leg to give the ultimate C leg target. In this example, the length of the A leg is subtracted from the top of the B leg to give the C leg target (see chart for calculation). Also notice on the weekly chart how volume has declined during the push off of the May low. This again shows a lack of conviction among participants.

(Click to enlarge)

I have tremendous respect for the pit traders that do this for a living. If there is no conviction among those that know this market best, why should we view it any differently?

Disclosure: Author short Crude Oil

Source: Is Crude Oil Headed Back to $57?