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Oil Market Update

Clive Maund
April 23rd, 2014

Oil has been a dull market for years now, with the price trapped in a relatively narrow trading range, which is why we haven’t paid it much attention in the recent past, but there are signs that this is set to change soon.

On the 8-year chart for Light Crude we can see that, after the fireworks of 2007 through early 2011, when oil was a huge play first on the upside, then on the downside and then on the upside again, when it recovered from being ridiculously oversold, it has run off sideways into a relatively narrow trading range that has taken the form of a gently Ascending Triangle. While Ascending Triangles are normally bullish, that is not considered to be the case here, because the rate of ascent of the price has been so gradual that it has been cancelled out by inflation, and also because the COTs for oil now look decidedly bearish, which we will come to a little later. Since early 2011 there has been little opportunity to make money in the oil market, unless you were able to catch the swings exactly, or wrote options when the price reached the top or bottom of the range, otherwise it has been a waste of time. Before leaving this chart we can see that oil has staged a relatively modest rally so far this year, but is still some way below the a zone of quite strong resistance in the $110 - $115 zone.

On the 6-month chart for Light Crude we can see how oil has had a nice little runup this month, but it has now run into resistance at its late February high. This resistance is not strong, so there is some chance that it will overcome it soon, especially as it had a good day on Friday, but even if it does it still has much stronger resistance to contend with in the $110 - $115 zone, not far above, which would be expected to cap any further advance. Keep in mind that COTs for oil are now very bearish.

While the performance of oil itself has been lackluster for a long time, the same is not true of oil stocks, which have enjoyed fairly substantial gains in the recent past as they have ridden on the coat-tails of the continuing advance by the broad stockmarket as a whole. There are signs, however, that their advance has now about run its course, which fits with what we are seeing in regard to the the outlook both for the oil price and the broad stockmarket. On the 8-year chart for the XOI oil index we can see the significant gains it has made in recent weeks and over the past year, but also how it is arriving at a zone of important resistance at its 2008 highs – a good place for it to go into reverse. Here we should note that, given that it is quite likely that the broad market will break out to new highs short-term before its current rally is done, in tune with the NASDAQ Comp making a symmetrical Right Shoulder high to complete its Head-and-Shoulders top, the XOI could rise a little further to the upper boundary of the resistance shown before its advance halts, meaning that it could make it as high as 1640 – 1650. If it does the sector will be regarded as being at a good point to short.

The 6-month for the XOI index shows recent action in more detail and how it has staged a significant rally in recent weeks, punctuated by a Flag consolidation during the first half of this month. This rally has resulted in it becoming quite over-extended, as shown by both its gap with its moving averages, especially the 50-day, and its MACD reading which is showing the oil sector to be quite heavily overbought. This makes it very likely that the band of strong resistance shown on the chart, which dates back to the 2008 pre-crash peak, will cap the advance and send the sector into reverse.

Now we turn to the oil COTs, which suggest a high probability that the oil price will break to the downside before much longer.

Our first oil COT chart shows readings going back a year. At first sight it looks fairly innocuous, with readings changing gradually, but when you compare the latest readings to those of a year ago, you see that Commercial short positions and Large Spec long positions have about doubled, which itself a bearish indication, as the Commercials rarely if ever lose, as a group, over the long haul.

When you look at the oil COT going back many years you realize that the situation is much more extreme than it looks on a chart going back just one year. Commercial short and Large Spec long positions have recently climbed to a record by a substantial margin, which is a strong indication that a serious reversal to the downside is pending in oil.

Finally we will look briefly at the latest general commodities COT chart, which shows an astounding shift in positions over the past several months. This chart has rocketed deep into a bearish extreme reading, which does not bode well for commodities as a group at all – what this implies is that commodities will be shot down in flames along with the broad market before much longer. Here we should note that this indicator can lead, and make extreme readings some time before commodities hit a peak, but nevertheless it warns of a looming serious reversal.

Clive Maund
April 23rd, 2014

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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