Oil Market Update
May 12th, 2008
Unless you think “it’s going to be different this time round”, which as we know from bitter experience it usually isn’t, it’s time to exit most positions in oil and oil stocks, which are now at major targets. Unless an unusual confluence of factors comes together to drive a vertical spike, or Bush and Cheney have a brainstorm and suddenly attack Iran, the odds are now high that oil is on the point of topping out here and we will soon see a substantial reaction or at least a prolonged period of consolidation.
On the long-term 7-year chart for Light Crude we can see how the vertical ascent of the past week or so has brought the price simultaneously to targets at the top of its intermediate and long-term uptrend channels, where the prudent trader will automatically take profits, disregarding any cheerleading or hype in the mainstream financial press, such as Goldman Sachs' recent claim that oil will reach $200, which it is suspected may have been motivated by the intention to whip up retail demand to absorb now highly profitable long positions. Oil has reached an overbought extreme, shown clearly by the MACD indicator at the bottom of this chart.
The 1-year chart for Light Crude shows recent action in more detail. We had in the last update misinterpreted the pattern that formed from last November and called a top too early as a result. It was thought to be a Flat-bottomed broadening formation, but instead turned out to be a Rectangle, the validity of which was substantiated by the successful test of support at its top boundary late in March. Nevertheless, the pattern does have a broadening tendency, and for other very important reasons, principally the attainment of trend channel targets in a very overbought state, oil is believed to have hit a top for this cycle. Oil has risen vertically over the past week or so, with 6 days up in a row - which could well mark the final peak for this move.
Although oil looks set to top out here and enter a corrective phase, which could be quite lengthy, it certainly doesn’t mean that its bull market is over, for as we can see on the 7-year chart it could react right back across its long-term uptrend channel, which would involve a heavy percentage decline, without endangering its long-term bull market.
Turning now to oil stocks, the 7-year chart for the OIX oil index reveals that stocks are close to hitting the top of their long-term uptrend channel, which dates back to early 2003, and are also extremely overbought as shown by the MACD indicator at the bottom of the chart. It is therefore time for traders to take profits in any remaining oil stocks in expectation of a reaction. The convergence of the uptrend channel, which is admittedly not great, does suggest some weakening, while the OIX oil index in Euros chart, which factors in the decline of the dollar in recent years, makes clear that the rate of appreciation of oil stocks in “real money” terms slowed substantially from the Fall of 2005, and they have looked increasingly weak over the past 10 months or so.
The 1-year chart for the OIX index shows recent action in more detail and on this chart we can see that it is very close to the top of a channel that began in August of last year, and which is subordinate to the long-term uptrend channel shown on the 7-year chart. This shorter-term channel highlights the possibility that oil stocks will top out here immediately, without hitting the long-term channel return line first, which fits with the situation in crude right now.
There will naturally be some concern amongst gold and silver and Precious Metal stocks investors that the oil sector topping out will negatively impact the PM sector, as gold and oil are known to move broadly in tandem. There need be no concern about this. The correlation between gold and oil is a long-term one, on an intermediate or medium-term basis they are often completely out of sync, dumb-belling around each other within their long-term uptrends. An important and timely article by Jordan Roy-Byrne entitled Why a Top in Oil is Bullish for Gold Stocks appeared on public websites some days back, in which this issue is addressed squarely.
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