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Oil Market update

by Clive Maund
www.clivemaund.com
December 18th, 2005

After the last Marketwatch Oil, which was bullish, crude did break quite sharply higher, and oil stocks advanced marginally to reach 9 week highs. However there have been several developments over the past week or so that give grounds for caution.

There is a broad consensus in the market - an uncomfortably broad consensus - that the uptrend in oil and oil stocks is set to continue. This was a view we have held ourselves as both oil and oil stocks had reacted back into classic buying territory, although we noted at the time that the decline in oil stocks in October was sharp, with many stocks declining on heavy turnover, and following the reaction we have indeed seen a significant partial recovery to date. However, on this site when we know that the mob are into something in a big way a red flag is raised, and the current large bullish consensus certainly gives grounds for caution. More concretely, the market itself has been flashing warning signals over the past few days.

The sharp drop by crude on Friday was a signal that the attempt to break out above the important strong resistance at the underside of the Summer-Fall Head-and-Shoulders top in the $63 - $64 area has failed, at least for now. Much more serious is that all the action from last June is now starting to take on the appearance of a large Head-and-Shoulders top, with this month’s advance comprising the right Shoulder, and Friday’s sharp drop commencing the completion of this Shoulder. If so this would explain the severity of the drop in oil stocks back in October.

The charts for the oil stock indices also look decidedly worrying. On the 1-year chart for the OIX oil index we can see the severe, panicky decline in October which halted where you would expect, at the 200-day moving average and the fact that the index stabilized above this indicator, with the oil price downtrend also reversing near its 200-day moving average, pointed to a new uptrend, and thus far we have seen a hesitant improvement. Until this month the chart had looked good, with what looked like a bullish ascending triangle developing beneath resistance at about 540. However, the attempt to push higher this month has made little headway, and Thursday’s and Friday’s retreat has altered the appearance of the pattern that has developed from mid-October, so that this triangle now looks like a potential bearish rising wedge. This fits with the Head-and-Shoulders hypothesis for oil outlined above and given that the suspected rising wedge in oil stocks is rapidly closing up there is obviously an increasing danger of a sharp breakdown soon.

The situation is still not conclusive, but due to the marked increase in downside risk for the reasons given above, it is thought wise for oil stock holders to generally defer further purchases until the picture looks less risky, which would be occasioned by the OIX index breaking out upside from this pattern, signalled by several closes above 550, and to tighten stops, for if the market breaks down from here a heavy decline is likely to ensue, due to the abrupt change in sentiment that may result in widespread dumping.

Subscribers are strongly advised to tighten stops in oil stocks across the board here - you don’t want to be around if this thing breaks down, and you can always get back in, albeit at slightly higher prices, if the situation improves. Clive Maund

Clive.Maund@t-online.de

Clive Maund is an English technical analyst, holding a diploma from the Society of Technical Analysts, Cambridge and living in southern Bavaria, Germany.

Visit his subscription website at clivemaund.com .[You can subscribe here].

No responsibility can be accepted for losses that may result as a consequence of trading on the basis of this analysis.

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