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Oil Market Update

Clive Maund
February 7th, 2012

Despite all the endless talk about Peak Oil and the growing probability of serious trouble with Iran, the oil price has not done more than flatline since the middle of 2009, apart from a brief foray above $110 in the Spring of 2011, as can be seen on the 5-year chart for Light Crude below, which shows a gently rising uptrend, although once you take inflation into account it is probably not rising at all, unless you believe the data used in the US CPI, which is why we say it is flatlining. Before all this we had the wild ramp of 2007 - 2008, followed by the crash caused by the 2008 financial crisis, before oil prices recovered to the mean before plodding sideways from mid-2009 to the present.

There are 3 main forces are work in the oil market at this time, the summation of whose effects determines the trend and has resulted in the continuing sideways action. One bullish factor is Peak Oil - it is being used up at a prodigous rate, although this is being offset by big finds in places like the Arctic - how convenient of the polar ice cap to melt at this time - the old mariners looking for the North-West passage would have had better luck if they tried it now, and perhaps in places like Los Malvinos (The Falklands) - sorry Argentina - now you know why the Brits were so keen to maintain the "right of determination" of a small remote bunch of sheep farmers, and while they are it they might go for a slice of Antarctica as well, perhaps in memory of Scott of the Antarctic, but I digress.

The next main bullish factor is Iran. Western powers have had Iran in their sights for a long time, both to eliminate a potential threat to Israel, and to grab their oil assets, and now that puppet governments have been installed in Afghanistan and Iraq, and the troops are being withdrawn, it's time to move ahead and finish the job of attaining suzerainty over the entire Mid-East and its resources. The excuse of Iran acquiring nuclear weapons is very similar to the story that was put about concering Iraq before its invasion - that it had weapons of mass destruction. On the chess board of the Mid-East, if Afghanistan were considered to have the significance of a bishop or knight, and Iraq that of a castle or rook, then Iran is the Queen - take that and you acquire complete control of the board. That is the game plan that we are witness to now. Will the conquest of Iran require the use of military force? - probably, although not necessarily. Other means are being used to soften up Iran, like the economic blockade now being imposed, although this could backfire on compliant Europe, if Iran decides to play hard ball and completely and suddenly shuts off exports to Europe, and intelligence services are working to subvert its rulers and ideally (from the point of view of the protagonists) foment revolution, and are doing such things as killing its nuclear scientists. Of course Iran may circumvent these restrictions by selling oil to countries like China and Russia in exchange for gold, as has been recently reported, but to whatever extent this is successful it will increase the probability of the job being completed by means of military force. It is an unpredictable and dangerous situation that could cause a sudden huge spike in the price of oil, depending on what happens, and the situation is made more risky by this being an election year in the US, so the current President, who is perceived as weak and a failure, may well be tempted to use military action as both a distraction from the weak economy and a way to present himself to the electorate as a "tough guy", although of course it will be other people's sons who go off and get killed, as usual. It is thought unlikely, however, that Iran will react to all this pressure by blocking the Straits of Hormuz, however desperate they may feel, because this would play right into the hands of their enemies who would then have the perfect excuse to turn up in force with a show of "shock and awe".

The third main factor having a major impact on the oil price is the state of the world economy, which is teetering on the verge of collapse due to massive and intractable debt problems, with the de facto decision having been taken to inflate the debts away into oblivion, the main objectives of this course of action being to keep the ruling elites in power as long as possible and to protect their vital interests, which center on the US banking giants.

Turning now to the charts and starting with the 5-year chart for Light Crude, we can see that these forces have largely cancelled each other out for the past two and a half years, as oil has drifted sideways in a trading range, which if adjusted for inflation during this period is probably horizontal as mentioned above. It did break out of the range for a while last Spring, but then slumped back into it. There is no immediate sign of this gentle uptrend coming to an end anytime soon so until it does we can assume that it remains in force, which for traders means buying near the bottom of it with a close stop beneath the support line of the uptrend, and selling or shorting near the top of it with a close stop just above the upper channel line, although here it should be pointed out that by the time a trading range becomes clear and obvious, it is mature and may be coming to an end.

Just as a mechanical approach to trading oil may be employed at this time, based on its long-term trend visible on its long-term chart, so it may be employed using the much smaller trading range that has formed over the past several months, which is shown on the visible on the shorter-term 1-year chart. The downtrend that followed oil's brief sojourn above $110 last year brought it back within its gentle long-term uptrend, and this downtrend ended with a Double Bottom that formed in August and October of last year. Immediately after a sharp uptrend occurred that peaked in October, after which the current trading range bounded by $92.50 and $103.50 developed. This range may turn out to be an intermediate top, but until it declares itself, traders can sell towards the top of it and buy towards the bottom of it, with close stops below or above the respective support or resistance. Right now the price is about mid-range, after the retreat from the start of the year.

The COTs for oil (not shown) are in neutral territory and do not provide much of an indication one way or the other.

Oil stocks actually look quite positive here and like they want to advance to higher levels, despite the indecisive look of the oil chart and the broad market sentiment indicators looking increasing bearish. On the 5-year chart for the OIX oil stock index we can see that the major uptrend that started early in 2009 remains in force and that prices are challenging a resistance level and looking like they want to break above it and run to the next one, and possibly higher. If they succeed in doing this it obviously increases the chances of oil breaking out upside from the range shown on the 1-year chart.

On the 1-year chart for the OIX oil stock index we can see that it is on the point of breaking out upside from a bullish Ascending Triangle and if it does we can expect it to run to the next resistance in the 870 - 900 area as a minimum objective, and if it were to make it as far as the upper boundary of the long-term uptrend shown on the 5-year chart, we would be looking at very substantial gains from here. It does seem rather improbable but with what may be looming in the Mid-East, it is certainly possible. What makes this current situation so attractive for anyone contemplating going long here is the highly favorable risk/reward ratio. This is because important support is close at hand, first at the lower boundary of the Ascending Triangle and then at 780, arising from past trading, with further support from the bunched 50 and 200-day moving averages just below that, so that stops may be set just below 780, or just below 760, with the former being preferred as it would result in reduced losses (although higher whipsaw risk). Either way, a sizeable move looks imminent in oil stocks.

Clive Maund
February 7th, 2012

Clive 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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