Crude Oil Update

In early May, I wrote that I thought the bounce in Oil was over, as most of my upside price targets had been met. Price has gone nowhere since, with a lack of follow through on the part of both buyers, and sellers. Admittedly, I’ve been bearish on oil this past month, and depending on the way you’ve played that theme, that may have been the right call. For example, US energy stocks and correlated markets like Russia, have sold off and provided swing-short opportunities. Crude Oil futures however, have held up quite well, thereby leaving you about flat if you played this thesis straight up. With that, I took the some time today to see what’s going on in this market and if there are any opportunities for a trade after this month of congestion.

First off, I think it’s important to look at the backdrop that helped spark the March rally off the lows. Beginning in March, we were entering the best seven month period of the year for Crude. Today, we’re still within that period, but the average performance in June and July isn’t quite as stellar as tends to be in March and April. Additionally, commercial hedgers were reducing short positions in March, hitting multi-year highs in terms of long positions, but have since began adding to short positions again. Lastly, in March, public sentiment was at 13 year lows, but we’ve since seen optimism move higher with price and come well off the lows.

Today, sentiment and seasonality do provide a slightly bullish tailwind for price, but overall, it’s not nearly as big a factor as it was at the March lows.

Looking at price on the weekly chart, it’s clear that Crude is in a structural downtrend, as shown by the declining 200 week simple moving average. Earlier in the year prices successfully tested, and confirmed, the uptrend line from the ’03 and ’09 lows, while momentum positively diverged. This, along with extreme sentiment readings and a strong seasonal backdrop ignited a nice rally off the lows. Prices are now consolidating above key support in the $55 area, which bulls want to see hold, or we risk a retest of the lows.chart

On the daily contract adjusted chart, we can see that prices rallied after a false breakdown below the January lows in mid March. We’ve since spent the past 5 or 6 weeks consolidating above support at 57. Momentum is still in a bearish range after not hitting overbought conditions on this rally and the 200 day is now just overhead at $68. Price action has improved recently, but until we break this 57-63 range, I don’t think there’s an edge in this market. Additionally the risk/reward, from a swing perspective, is ten points in either direction. Would could either see a rally toward the 200 day, which is 10 points above this level, or a breakdown back toward the YTD lows, which are 10-12 points below us. At 1/1, the risk/reward doesn’t appeal to me.chartFrom an intermarket perspective, price action in the correlated foreign equity markets such as Russia and Malaysia, has been quite dismal this past month. Additionally, US energy stocks as a whole have not held up as well as Crude, whereas they had led the rally in March after not making new lows with the futures market. I did note that price action has improved over the past few days in areas like XOP and OIH, but with the 200 day just overhead in these sectors as well, I think the upside is limited. Another thing I noticed was that XLE looks surprisngly bad, with names like XOM and CVX looking like death.

The Bottom Line: The Crude Oil trade was a much easier one in mid March when all the evidence pointed to higher prices. Today, with sentiment and seasonality tailwinds less prevalent and prices stuck in this binary range with 10 points of upside/downside, I think there are better trades out there. If you wait for confirmation of which way this 57-63 range breaks, you may get a nice swing trade, but I think anticipating which way it’ll resolve is tough here. Lastly, from a structural perspective, bulls really want to see this 55 area hold on the weekly, as below that we may be due for some more volatility and another test of the lows.

As always, if you have any questions feel free to reach out and I’ll get back to you as soon as I can.