Crude Oil Historical Behavior Shows A Bounce To $50 Is Doable

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Includes: CVX, RDS.A, RDS.B, USO, XOM
by: Chris B Murphy
Summary

With the OPEC production cuts being largely offset by the increase in U.S. oil production, crude oil has traded in ranges while currently favoring the downside.

When the fundamentals are conflicted, price sometimes follows a pattern of behavior on its way higher or in the current situation for crude, lower.

However, given the channel crude has been trading within so far this year, a bounce and a possible rise to $50 is doable if the fundamentals line up.

The crude oil market doesn't know whether it's coming or going. On one hand, OPEC is cutting production and yet on the other hand, U.S. production has been resilient despite lower oil prices. On one week, we see inventory levels rise only to see them fall in the following weeks. And with anemic economic growth, measured by Gross Domestic Product or GDP, both in the U.S. and in China, it's no wonder oil is having a crisis of confidence.

As a result of conflicting fundamentals, oil has been trading in ranges that when broken lead to a temporary move higher or lower only to settle in a new range. These channels have trapped crude oil at times in a bullish channel and currently in a bearish channel.

Until the fundamentals change in a convincing manner, one way or the other, we're likely to continue to see these channels play out. In this article, we'll analyze the behavior of crude oil within these channels YTD and why $50 oil could be possible.

For those invested in crude via ETFs like the United States Oil ETF (NYSEARCA:USO), or in energy stocks like Exxon Mobil Corporation (NYSE:XOM), Chevron Corporation (NYSE:CVX) or Royal Dutch Shell (NYSE:RDS.B) (NYSE:RDS.A) the behavioral patterns of crude will need to be closely monitored until fundamental changes occur breaking oil out of its current bearish trend.

It's important to point out, the charts (or technicals) don't drive price action. Instead, the fundamentals have created the patterns on the charts, and only the fundamentals can cause a break out of the current patterns. In short, the charts are merely a visual representation of the symptoms of the fundamentals in the market.

Chart from March article:

  • In March, we discussed the bearish break lower out of the channel at that time (blue line) and how the market loves to retest a former support break (going back higher).
  • As a result, the article warned of a false rally higher and to watch for traders selling into rallies.

Chart from April article:

In April, my article warned of a rally to $51.90, and a fail as traders who were underwater in their long positions would unwind to cut their losses on a move higher back to former support (pink line).

The chart below shows how the crude oil rally & fail played out:

  • In March, crude oil went to $53.30 and failed.
  • In May, crude oil went to $51.95 and failed.

With the conflicting fundamentals, traders have been selling into rallies and buying on dips with mostly short-term positions.

Why is crude oil failing and bouncing at those particular levels?

Crude oil behavioral analysis for 2017:

  • As we can see from the chart, oil has been in a downward channel (blue lines) since February this year.
  • For those of you that follow my articles on SeekingAlpha.com, you know that I like to analyze the angle of price action. In other words, the channel was defined by price movement (not me) and by cloning the upper blue line where crude failed, and taking the cloned line and matching it to where crude bounced (the bottoms), we create the channel. By cloning the top blue line, the slope of the channel both on the top and the bottom is identical.

When the fundamentals are conflicted, and the market is trading in a channel, price can trade in equal waves (although not always).

  • Around March 20th, we can see from the rally higher that crude moved 6.7% higher off the bottom of the channel, stalled and then continued higher for another 6.3% move before being rejected by the top of the channel.
  • The move lower in April to May also consisted of two waves lower, one for 8.5% and another for 10.5% until bouncing off the bottom of the channel.
  • The 10.5% move through the bottom of the channel in May was technically not an equal wave (to the 1st half of 8.5%). However, we can see from the wick of the candle (green circle) that sellers tried to take crude lower and buyers rushed in and took control forming the wick (bullish signal). Incidentally, the day's price for crude closed around the level that equates to roughly an 8% move.
  • The bullish move higher for the month of May consisted of two 9% moves to the top of the channel at $51.90 where crude failed and collapsed once again to the levels we're at today.

If the crude oil price behavior remains consistent, we may see a bounce when it completes the 2nd 8.5% bearish move which began around mid-May and could form a bottom around the $43 to $42 area (see the red rectangle).

Of course, the fundamentals mentioned above will be the determining factors in the direction of crude not the charts.

How the fundamentals might drive the charts (see chart below):

  • For investors looking to initiate a long position in crude, we want to see a bottom form around the lower blue trendline of the channel.
  • With each bounce off the bottom, we want to see hard bounces (look for large green candles like the last move higher).
  • We should also see higher lows and a steady rise in crude past the $46.50 mark.
  • For a bullish move in crude, we want to see a daily close above $46.50 preceded by higher lows.
  • If the fundamentals line up for crude rising, investors could look for a top around the $50 area or the top of the channel.
  • Obviously, it depends on the fundamentals (outlined on the chart), but it may take some time for investors to enter a position since they'll need to watch for some key determinants. They'll need to identify the bottom, allow crude to position itself by bouncing a few times, and watch for a steady rise in crude to take hold and head back to its top position at the upper line of the blue channel.

  • If the fundamentals turn negative for crude, a break beyond $42 (and a daily close below it) could push it down to the $40 to $39 zone.
  • Whether crude will go that low will largely depend on the fundamentals outlined earlier. Nonetheless, I'm still optimistic a bounce higher is doable, once we see the bottom show itself and visual evidence it's an attractive entry point (higher lows) which will again be determined by the fundamentals behind the momentum driving any push higher.

Good luck.

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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.