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Oil Market Update

Clive Maund
support@clivemaund.com
October 11, 2010

We haven't paid much attention to the oil market in recent months because compared to the Precious Metals sector it has been too dull, but there are signs that it may be about to get more interesting. Oil has been bogged down in a relatively narrow trading range for a year now, and for a long time it looked like a complex Head-and-Shoulders top was forming, which was associated with the earlier deflation threat, but with QE (Quantitative Easing) coming to the fore as the universal solution to all economic problems, it is looking increasingly like oil is going to go the way of silver, which had also looked like it was topping out, and abort the potentially bearish pattern that has existed up to now and suddenly break out upside.

On the 3-year chart for Light Crude we can see the potential Head-and-Shoulders top that has been forming since October of last year, and how, after apparently completing the Right Shoulder or Shoulders of the pattern, it has rallied sharply back up to the important resistance at the Shoulder highs that has turned the price down 4 times already. With commodities generally responding favorably to generous helpings of QE which now look set to continue and increase, notably gold and silver of course, there is a good chance that oil will soon bust through this resistance and go on to take out the lesser resistance at the April highs and in the process abort the H&S top to commence a significant intermediate uptrend. Although short-term overbought, as shown by the RSI reading, which was the reason for Thursday's reaction, it has substantial upside potential over a medium-term timeframe, as is made clear by the MACD indicator at the bottom of the chart.

While the 6-month chart for Light Crude is of limited use technically, as you "can't see the wood for the trees", it does enable us to examine recent action in more detail. On it we can see the sharp rise late last month and into this month that took the price up to the resistance level at the Shoulder highs, where it has not surprisingly stalled out temporarily, which is allowing the short-term overbought condition to ease. After Thursday's and early Friday's reaction, Friday's later trade recovery was positive and with moving averages in increasingly bullish alignment, oil is well placed to break above the resistance shown soon.

Oil stocks have made a reasonable recovery from their June - July lows, which has of course been on the back of the advance in the broad stockmarket during this period. However, gains have been rather muted due to heavy overhanging supply and unfavorably aligned moving averages. We had earlier identified a bearish looking Broadening Top in the OIX oil stock index shown on our 3-year chart here, and while this pattern is still far from being negated, there is evidence that, in the event of oil breaking out upside from its current trading range, it will be and if that happens the gentle long-term uptrend drawn from early last year will likely become operative. This uptrend is shallow, however, which is related to the continuing overhanging supply at higher levels, so even if the index succeeds in breaking out above the resistance shown and aborting the Broadening Top, it will not have that much further to go before it runs into the resistance at the top of the large channel. For this reason it is considered prudent for holders of oil stocks to generally unload them as the resistance zone is reached and switch the released funds into Precious Metals stocks, which should by that time have broken well clear of their 2008 highs on their indices and be advancing in strong uptrends.

The 6-month chart for the OIX oil stock index shows recent action in detail. Here we can see that while oil stocks are getting overbought, the index moving averages are swinging into increasing bullish alignment, which is increasing upside potential.