Tuesday, August 2, 2016

Crude Oil Bear Market May Have Already Ended

Crude oil entered a ‘bear’ market last week when it traded 20% lower from its early-June high.  There are plenty of reasons to expect the nearly 2 month decline in oil prices may soon end.  Economic developments, foreign exchange and technical developments all give warning for a possibly dramatic recovery in oil prices.  A reverse has not been confirmed, but more aggressive position-takers might step forward now.  Risk adverse position takers are recommended to await confirmation with a settle above a resistance trend line noted below.     

Last week’s GDP report showed surprisingly weak headline growth.  The ‘surprise’ came largely through an inventory drawdown (durable manufacturers (-0.4pp); nondurable wholesalers (-0.5pp); and retail motor vehicle dealers (-0.4pp).  For the 5th consecutive quarter, the longest stretch since 1957, slower inventory accumulation held back GDP growth. 

Recent gains in consumer spending, an indication of unleashed pent-up demand will further strain inventory levels unless those inventories are soon brought back in line with the longer trend growth.  Stronger H2 production for the purpose of rebuilding inventories should have an impact on crude oil demand and provide some support against the recent dramatic decline from the early-June high.   

Crude oil (CL1 –the rolling nearest to expiry future, currently CLU6) fell nearly 25% from $52.73 in early-June to a low of $39.26 today.  CLU6 has had 12 new session lows since July 15th and should thus be considered stretched or at least modestly oversold.  Whether oversold conditions are enough to right this falling commodity is yet to be determined.  According to Edinburgh-based Wood Mackenzie Ltd., there will be a capital expenditures reduction of $1 trillion by oil companies.  Weaker prices have therefore had a serious impact on investment and future oil production in this field.  It is argued that this reduction in expenditures will have a bullish impact on oil prices that could materialize at anytime.     

Technically speaking, crude opened slightly higher today and formed a potentially bullish ‘inverted hammer’.  Today’s price action, despite making an additional new low has shown some indecision.      There is a very sharp ($0.70 decline per session) downward sloping channel trend that has collected trade since July 21st.   The lower support trend line of this channel was tested again today and held.  This channel has a resistance line that would intersect trade on Wednesday August 3rd at $40.71.  The same channel should offer support at $38.75.  A settle above the upper trend line at $40.71 would add to the aforementioned bullish developments.  A settlement below the lower support trend line at $38.75 would mean a step-up in bearish momentum that would not be expected to persist and instead would likely result in more violent recovery price action.      

Finally, a weaker U.S. dollar should help to support higher oil prices going forward.  DXY (dollar index) is lower by nearly 2.5% from the 97.57 high of last Tuesday.  If the dollar remains range bound or lower, oil prices should react positively.  

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