Cracks in the Crude Oil Market?

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Includes: OIL, SPY, UUP, XLE
by: Wayne A. Corbitt

Yes, crude oil hit its highest price level since October 2008 on Thursday, but it is still effectively rangebound. How can this be?

The chart below shows that crude oil is now merely back to the top end of its six month old range. Yes, the range bound pattern has the definition of an uptrend with higher highs and higher lows posted along the way, but this is about as benign as an uptrend can be and still be labeled as such .

All of those out there celebrating Friday's jobs report as further evidence of 'economic expansion' could be in for a major surprise if crude oil does what it has done the last two times it has traded at this level.

Notice in the chart below how the price of crude has been in a gently up sloping range since last October, hardly the look of a market ready to explode to $100 as many have predicted.

Also take a look at the ten period stochastic in the bottom pane. That shows once again that momentum has been flagging on this last push to the upper end of the range.

Not only is crude oil at the top of its range on suspect momentum, but the commitment of traders data shows large speculators near the same level that prompted selling in October 2009 and January 2010. When speculative levels get this high, it means that most of the buying for the move has already occurred, leaving the door open for a move to the bottom of the range.

Also, let's consider the price of crude oil in dollar terms, which is fair since the West Texas Intermediate futures contract is priced in dollars. Recent dollar strength has eroded the value of crude oil. Even though it moved out to a 17 month high in pure price terms, it has not even broken out to a new 2010 high in dollar pricing terms.

Below is a spread chart of crude oil and the dollar. When the black line is rising, crude oil is rising in price relative to the dollar. When it is falling, crude oil is less valuable in relation to the dollar. Notice how crude oil has made lower highs since October 2009.

Finally, let's take a look at a chart I have presented more than once of late. It contains a spread between U.S. energy stocks (NYSEARCA:XLE) and the S&P 500 (this is the black line). The price of crude oil is also plotted (the red line). When energy stocks are leading the broader market (a rising black line), that is good for the price of crude oil since energy stocks are, in effect, leveraged bets on the direction of crude oil, which means that market participants are expecting higher crude oil prices. When the black line is falling, that means that energy stocks are underperforming the broader market, which usually coincides with a weaker crude oil market.

Notice lately how the divergence between the price of crude oil and the XLE/SPYspread has not narrowed. Even the dead cat bounce of the energy stocks last week is not enough to fool savvy investors into biting on this 'rally'.

So while many out there are calling for an upside explosion that seems inevitable, once again I am urging crude oil bulls to keep their powder dry for now. For this to be such a slam dunk trade, there are many issues underneath the market that warrant closer attention.

Disclosure: No positions