Oil: $40's Importance

| About: The United (USO)

Summary

We've said we expect oil to go lower since July 11.

We don't have a price target and are letting price decide itself.

$40 is a critical 40 year level that we just reached.

If it holds below $40 it has more downside near term.

We recommended an oil short July 11th (NYSEARCA:USO)(NYSEARCA:OIL)(NYSEARCA:UWTI). Since then we've pointed out critical price levels that have meaningful short and long term significance. We reached and closed at $40 in a hurry. We take that to be bearish and are watching to see if it holds.

On July 28th we showed that $40 is a key 40 year level. Traders often look for shorter term levels to have significance. We think a 40 year level has incredible significance.

Here's what we said July 28th on $40 oil.

"We see the next stop being $40. $40 is a major point going back 40 years. Breaking that is very scary and can flip people bearish. The next stop is $36. The next stop is $31, and the last is $25."

We quickly closed just at $40 as of yesterday. We'll have to see if we can close below it to tell us if it can drop further.

Click to enlarge

You can see we just missed closing below $40. About 5 bars in from the right is 2:30 PM. That is the time "pit" trading is officially closed and post-2:30 is considered after market. We judge the close based on 2:30 PM EDT.

It did not yet close below $40. We think it can.

We think closing below $40 will mean we have a good chance of going to $36. Then we will see how oil acts around $36 to decide if it is en route to $31 and $25.

Here is the longer term chart that has us focused on $40.

Click to enlarge

Above you see $40 has acted as a key support and resistance over the last 40 years.

*$40 determined a breakout in 2004

*$40 held a try to breakdown early this year.

*$40 stopped a breakout in 1990.

*$40 held a breakout early 1980.

Why we think closing below $40 should not be difficult.

As the price drops the rhetoric from OPEC nations seems to worsen. That tells us that OPEC is losing to game theory. As economies around the world (including OPEC nations) soften they are forced to speed up oil sales to make up for the lower priced oil. That higher production cycles on itself and drives the price down further.

*An Iran minister just said, "The oil market is oversupplied now but there are expectations that there will be balance."

We take that to mean that prices can continue lower.

*We recently reported that a minister from Saudi Arabia just said, "We believe that Saudi Arabia should not be the one to assume the lion's share of cuts."

That sounds to us like frustration that OPEC production is rising without consensus. The next OPEC meeting is not until November 30th. We don't expect a consensus to hold production until then, at the earliest.

Reuters just reported that their survey shows that OPEC production likely was up in July as well.

Recent news all calls for higher supply and lower demand.

For that reason we see a break of $40 as reasonable.

Conclusion

We continue to let price dictate the trade in oil. On July 11th price showed us it was forming a downtrend. Now the market price has quickly converged to an important 40-year level at $40. We think it can break it but we need to respect markets and see how oil acts to decide the next move.

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I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.