Oil Market Update
November 27th, 2011
The prediction for another downleg in oil made in the last Oil Market update posted in mid-September came true, as it then proceeded to drop back quite steeply to support at its August lows, as we can see on the 10-month chart for Light Crude shown below. After that, however, a strong uptrend developed which broke oil out of its larger downtrend in force from early May. This uptrend eventually stalled out about a week ago at the zone of resistance that we had previously delineated in the $102 - $104 zone, with a "bearish engulfing pattern" suddenly appearing on the charts, suggesting that an important intermediate reversal was occurring and immediately after oil broke down from the steep uptrend shown on the chart.
The rise from the early October low to the high about a week ago saw oil appreciate by about 33%, so this was a very significant gain, especially as it occurred against the background of a lacklustre performance by most other commodities. The extent of oil's outperformance is made clear by the 1-year chart below, which shows oil's performance relative to the Reuters CRB commodity index. These charts give credence to the analysis recently put forward by the eminent Dr Kent Moors, whose conclusions are that a supply squeeze is imminent, caused by a shutting down of production following the collapse in the oil price during the 2nd half of 2008, the results of which are now coming out the other end of the pipe (no pun intended). So does this mean that the oil price will now rocket? - not necessarily. If Dr Moors is correct, and there is no reason to suppose that he isn't, AND markets, especially commodities generally, hold up, then yes, we can expect oil to continue higher - the positive relative strength implies as much. However, if does not look like markets are going to cooperate over the short to medium-term - they look set to drop steeply and possibly even crash, due to the worsening crisis in Europe and probable contagion damage to US and other markets. Since severe recessions and depressions tend to dampen demand for most commodities including and especially oil, the effects of a global market downturn would likely override the positive effect on prices that Dr Moors highlights resulting in the price dropping despite the supply squeeze that would otherwise have a positive impact. This is the implication of the bearish engulfing pattern and trendline failure that we can see on our 10-month oil chart above. The oil price is therefore expected to drop over the short to medium-term.
The long-term 5-year chart for Light Crude shows that the overall trend for oil remains neutral/up, with the price having held above very important support in the $70 area when it dropped back in August and September. However if commodities should accelerate into a steep drop soon as looks likely, then oil could quickly drop back to this support level again and possibly crash through it, which would be bad news indeed for oil prices.
Oil stocks broke down from the Triangle shown on our 6-month chart for the OIX oil index, as predicted in the September update, but then turned higher and rose briskly throughout October on the back of the strong advance in crude prices and in the broad stockmarket. The advance in the oil stock index took it to the strong resistance shown in the 800 area where a topping Triangle formed before it broke lower to enter the current downtrend. Its fate now depends on what happens to both the oil price and the broad stockmarket, and as these are both expected to drop sharply, especially the latter, the current downtrend could accelerate and become steep going forward.
The 5-year chart for the OIX oil index shows where important support comes into play - at the lower boundary of the large uptrend channel shown, currently in the 660 area and rising. It is this trendline support that arrested the September decline and generated the strong rally in October. Can we expect it to do likewise when the index drops back to it again? It is possible but considered unlikely because of the outlook for an accelerating abd severe decline in the broad stockmarket and to a lesser extent oil itself going forward. A scenario considered likely is that it bounces off the supporting trendline, probably briefly, before reversing to the downside again and breaking below it before going on to drop more steeply.
A wild card that we should always allow for in this analysis is the situation in the Mid-East where there is possibility of some kind of intervention in Syria or a military strike on Iran. Although these possibilities are considered to be rather remote they are perhaps somewhat heightened at this time by the fact that beleaguered politicians such as Barack Obama have a tendency to divert attention from domestic problems and increase their popularity by engaging in conflict to distract the masses' attention and get them to rally around the flag - and the US certainly has enough guns n' ammo to engage in such external adventures.
November 27th, 2011
Maund is an English technical analyst, holding a diploma from
the Society of Technical Analysts, Cambridge and lives in The Lake District, Chile.
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