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Oil Market update

Clive Maund
February 16, 2007

In January oil broke down dramatically from a 5-year uptrend and plunged steeply in the early part of the month, only to rally almost as steeply in the latter part of the month and early February. However, this rally looks like a classic bear market rally following a breakdown, that will soon be followed by renewed decline.

On the 6-year chart for the West Texas Light Crude we can see the breakdown from the long-term uptrend, and how the subsequent rally has brought the price back up to an area of strong resistance at the underside of the trendline. With moving averages now in bearish alignment, we would normally expect the price to roll over and head south shortly.

On the 1-year chart for Light Crude we can examine recent action in a lot more detail, in particular the unusual action in January when the price dropped steeply in the first half of the month, only to rally strongly in the 2nd half of the month to recoup nearly all of the losses. Quite obviously oil is really “up against it” here, battling against heavy resistance from alarmed buyers in the aborted intermediate base formation, who bought between late September and late December and made huge paper losses on the plunge in January and are now seizing the opportunity to get out even. This resistance is compounded by resistance at the underside of the broken long-term uptrend line and by the bearishly aligned moving averages, with the advance having stalled in the vicinity of the 50-day moving average. In view of the combined strength of this resistance, it is somewhat surprising that oil has managed to rally as far as it has, but it is attributed to the distant but incessant beating of war drums over Iran. An attack on Iran is viewed as the only factor likely to reverse the current downtrend in oil, and a change from bearish to a bullish tack would be clearly signaled by oil advancing above the important and very strong resistance at and just above the $64 level.

Oil is regarded as a good short sale here, and especially on any short-term rallies at the underside of the long-term uptrend line. The risk/reward ratio is favorable and can be tightly managed by means of an overhead stop above the trendline. If it should climb above this, the next point to short it is towards $64, with a stop above the strong resistance at about $64.50.

In view of the dramatic plunge by early in January, it must be said that the way oil stocks have held up is nothing short of amazing - they did not even come close to breaking down from their long-term uptrend. However this should not be viewed by those long oil stocks as grounds for complacency. There are 2 main reasons why oil stocks held up. One is the massive profits still working their way through the pipeline that will accrue from the high oil prices through much of 2006. The other is the buoyancy that has been provided by the continuing ascent of the broad market. The big profits are great, but will soon have been discounted, and the broad market won’t go up in a straight line forever - the risk of a setback is increasing the higher it goes, and when it goes it can be expected to take oil stocks with it. Of course, as with oil itself, if Iran should be attacked, oil stocks can be expected to go through the roof, but with this proviso taken account of, there are otherwise grounds for considerable caution with oil stocks going forward, an a reaction back to long-term trendline supported is considered likely soon, in sympathy with a retreat by oil itself.

Before closing it is worth taking a look at the 1-year chart for the US Oil Fund, whose movements closely mirror the movements of oil itself. What is interesting to observe on this chart is the dramatic buildup in volume as the price fell early in January, until it rose to reach climactic proportions as the price - and the price of oil - bottomed. This was a classic selling climax indicative of a bottom, an intermediate bottom at least.


Clive Maund
Feb 16, 2007

Clive Maund is an English technical analyst, holding a diploma from the Society of Technical Analysts, Cambridge and lives in Copiapo, 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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