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Oil Market Update

Clive Maund
August 10, 2008

We have had the heavy correction in oil predicted in the last Oil Market update which was posted in mid-July, with the pendulum rapidly swinging from extremely overbought to extremely oversold. On the 3-year chart for Light Crude, the correction looks quite normal. Before it set in oil was wildly overbought with a huge gap having opened up between its 50 and 200-day moving averages, this gap being a key factor leading us to conclude that a major correction was imminent. The MACD indicator had also been riding at extreme levels for weeks, which was another important factor calling for a reversal. Now this indicator has plunged to its lowest level for years as speculators have rushed for the exits, a level that equals the most extreme reading attained during the uptrend, showing that selling has been way overdone - and although the price could retreat a little further short-term, we are now probably very close to a reversal. On the chart we can see that the price is now approaching the strong support at the lower boundary of the uptrend channel in force from early 2007 and also support in the vicinity of its 200-day moving average. These important supporting factors coupled with the deeply oversold condition should lead to a reversal to the upside soon.

On the 6-month chart for Light Crude we can see that while the price pattern has certainly not signalled that the downtrend is over yet, there are factors in play suggesting that it does not have much further to run, and should end soon, if not immediately. There are 2 things in particular that are worthy of note. One is that the downtrend appears to be taking the form of a bullish Falling Wedge. It is too early to be sure at this point, but if the tentative lower channel line drawn on the chart is correct it is showing a gradual diminution of selling pressure over time, which would seem to be the case, for as we can see the MACD histogram is creeping back towards the zero line, despite the continuing losses. It is thus reasonable to conclude, given that oil stocks, which appear to have bottomed, tend to do so ahead of oil itself, that although oil may drop a little more more it is close to bottoming and is likely to do so in the $110 area.

Despite the fact that they have been and are making mountains of money, oil stocks have dropped substantially over the past several months. This is because the market is always discounting future (foreseeable) developments 6 to 9 months down the road, and, unsettled by the heavy declines in the broad stockmarket earlier in the year, investors have been looking ahead to somewhat lower profits resulting from recession and lower oil prices. The fact remains however that oil companies have been making gargantuan windfall profits out of the recent boom in oil prices, and have built up massive "war chests", which will scarely be dented by backhanders to their pals in the Republican Party. Bearing this in mind, it should be clear that with oil having now corrected back heavily as oil stocks had anticipated, the stage is set for a new uptrend to develop. On the 3-year chart we can see how the OIX index has dropped back across its broad long-term uptrend channel to its lower boundary where it is logical and reasonable to expect it to find support and turn up again. That it is finding support towards this uptrend line is evident from the fact that the rate of decline is now slowing. The overbought extreme attained in May has been followed by an even more oversold extreme just a couple of weeks ago, as shown by the MACD indicator at the bottom of the chart.

There are many interesting features to observe on the 6-month chart for the OIX oil index. After a minor reaction late in February and the first part of March, a strong "bull hammer" marked the reversal that led to the following powerful uptrend, which terminated with a fine example of a bearish "shooting star" candlestick in May. The index then formed an intermediate top above its 50-day moving average before breaking down below a clear line of support (now resistance) at the 920 level leading to the recent plunge. It became critically oversold by late last month, as shown by the extremely low MACD reading, leading to a slowing in the rate of decline. Now it appears to be marking out an intermediate base area with downside momentum clearly having slowed considerably. A bullish Falling Wedge pattern is now evident on the chart, although it is too early to be sure of this, but if this is what it is we can expect a strong reversal to the upside soon, and recent candlestick action is decidedly bullish, with several long lower shadows demonstrating the underlying demand snapping at oil stocks when they dip - doubtless only too happy to buy from the clowns who are bailing out, probably with heavy losses. On Friday a bullish hammer candlestick appeared on the chart, the low of which may be very close to the bottom for this cycle.

Oil stocks are believed to have bottomed, or to be very close to bottoming, and to be presaging an imminent intermediate low in oil, likely in the $110 area.

On Friday on we liquidated our Proshares Ultrashort Oil & Gas ETF units (code DUG), having bought them a week before oil topped out.

Clive Maund
August 09, 2008

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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