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Oil Market Update

by Clive Maund
January 24th, 2006

The general US stockmarket suffered its biggest one-day drop for a long time yesterday and many investors are probably wondering about the potential impact of a major decline in the broad market on the Precious Metal and Energy sectors. In a nutshell it would be expected to have a significant negative impact on the Energy sector, for the simple reason that the reduced economic activity associated with a recession/depression resulting from a market plunge would reduce demand for oil and gas, but gold, which thrives on chaos and uncertainty, should continue to shine, although gold shares may get temporarily dragged down by a general market plunge.

Now at this point it should be stated that I do not have a good record with respect to calling the general market over the past few years, although I am in good company as few others do either. This may be due to the activities of the PPT, the Plunge Protection Team, who have weighed in with huge quantities of cash to prop up the broad market at key inflexion points, and thus prevent normal corrective forces from running their course. This of course implies that if the PPT lose control of the situation they could be faced with a runaway decline of frightening proportions.

Thus it is potentially of great significance for the oil sector that the oil stock indices yesterday challenged - and shied away from - their September highs yesterday. This was hardly surprising as the broad market was plunging, but if the broad market decline turns into a rout, the oil sector can be expected to get taken down with it, and if that is the outcome it means that the oil sector is now Double Topping with its September highs, following the strong advance this month. It is simply not known if yesterday’s sharp drop in the broad market was a “one-day wonder” - the market is short-term oversold - or if it will go on to crash support near the 200-day moving average which could lead to a rapid meltdown, but the intraday reversal at the September highs by oil stocks yesterday certainly gives grounds for caution with regard to this sector.

Thus - because we are so close to the September highs, and therefore in possession of virtually all of the gains resulting from the rapid advance this month, it makes strategic sense to liquidate/partially liquidate oil stock positions here and stand back and watch. This market is, in any case, now short-term overbought with a large gap having opened up with its 50-day moving average and would probably need to consolidate here even if it goes on to break higher. From the safety of the sidelines you then have 2 options - to buy back in should the broad market stabilize AND the oil stocks indices break out to new highs - because we are so close to the September highs you won’t miss much of the action by doing this, or, if the broad market does go into a heavy decline resulting in a Double Top and then a drop in oil shares, they can be repurchased later at substantially lower prices.

Clive Maund

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

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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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