Oil Market Update
August 23, 2007
In the last update we predicted the failure of the intermediate uptrend in crude a day before it occurred, on the basis of analysis of COT data coupled with severe deterioration in oil stock prices. The action in oil stocks presaged the breakdown in oil itself and right now, with oil stocks showing signs of bottoming, they look set to presage an intermediate reversal in oil again.
On the 1-year chart for Light Crude we can see the breakdown early this month, which followed an unbroken 2-month uptrend. However, this is certainly a bullish looking chart overall, with the price advancing away from a large, irregular Head-and-Shoulders bottom. The fact that the intermediate uptrend failed early this month is hardly surprising after a steep 2-month uptrend that took the MACD indicator shown at the bottom of the chart to a level indicating a very overbought condition. Following the breakdown the price has reacted back to the $70 level where it has been finding “round number” support, although substantial support only comes into play around the $67 level, and the current rather large gap between the 50 and 200-day moving averages indicates a strong probability that the price will react back towards this level, although it may not get that far before the new uptrend begins. Thus, crude is viewed as a buy in coming weeks on further decline towards the $67 area.
The COT chart shows the extreme Commercial short position early this month that enabled us to predict the breakdown in crude. There was an element of luck in this as these figures are deliberately released late to keep ordinary investors in the dark - in this case the market obligingly didn’t plunge until several days later. Not surprisingly, the Commercials short position has since dropped considerably as the price has gone into retreat, although it is not yet at a level that signifies that the time is ripe for a new uptrend to begin. We won’t know, of course, what level the Commercial short position dropped to on the plunge into Thursday until this Friday, of course. Thus, it is considered likely, given in addition the location of the next important support level in the $67 area, and the large gap between the 50 and 200-day moving averages, as mentioned above, that oil will drift somewhat lower in coming weeks towards, but probably not reaching, $67, even if oil stocks have already bottomed as suspected.
Oil stocks are a rather different story. Just as they topped out before crude, they appear to be bottoming out before it now. We exited most oil stocks too early on the preceding intermediate uptrend which took prices to the upper limit of expectations. Actually they exceeded our best expectations by hopping above the uppermost return channel line on the 2-year OIX oil index chart shown, and as is customary when this happens, they then did a rapid about face and plunged - but at least that meant we weren’t around by the time this happened. As we can see oil stocks have now fallen into the target zone given in the last update, where it was stated that the drop should take the index at least back to its 200-day moving average, and possibly back as far as the lower channel line, currently at about 655. Last Thursday’s dramatic Reversal Day in this index and in the broad stockmarket signifies, however, that the low is probably in - this low being the intraday low on Thursday, which the index may approach again in coming days and weeks, presenting a better buying opportunity. As usual, would be buyers face the conundrum of buying now, or angling for better prices in the weeks ahead that would be presented by a retest of the lows, and thus risking missing an upside breakout in the meantime. This dilemma is considered best handled by partial purchases around current levels and completion of buying on a dip should it occur.
One final point - oil is the lifeblood of the modern world, and barring an all-out market crash, which doesn’t look likely despite recent jitters, oil companies generally, and especially large oil companies, which are relatively immune from the risks afflicting smaller companies, can be expected to continue to do well. This means that the inevitable periodic corrections in large oil stocks such as we are now seeing present windows of opportunity for investors to take positions in these stocks, which in addition to their growth potential, also pay good dividends.
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