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Oil Market Update

Clive Maund
September 25th, 2012

There is a huge difference between oil and the Precious Metals as investments. The price of oil is determined by global demand that is directly related to the level of global economic activity, whereas demand for Precious Metals is not necessarily dependent on the level of economic activity at all, it could result instead from safe haven investment when the economy is collapsing.

Right now there is a widespread assumption that with the bankers and Wall St having been granted QE to infinity, they are going to go on a more or less permanent shopping spree, driving up the commodity and stockmarkets even as economies wither and in some cases implode before the overarching forces of stagflation. This could prove to be a very dangerous assumption. We have already seen that the Baltic Dry index, which is an index of shipping rates that is a barometer of world trade, is plumbing 2008 crash lows, and it is highly doubtful that the excuse made that this is due to a “glut of ships” is sufficient to explain the extraordinary drop in shipping rates. In addition, the Chinese economy is in freefall and could be heading for a nasty hard landing.

So, given that we know that QE3 is not going to stimulate the economy, just as QE1 and QE2 didn’t, and it is essentially a taxpayer funded handout to the banks and Wall St, which will be paid for via a devalued dollar and inflation, the question becomes one of whether the banker and Wall St QE fuelled shopping spree is going to be sufficient to support prices and drive them higher in the face of potentially collapsing demand as global stagflation tightens its grip. The best way to answer this crucial question is, as usual, to let the charts answer it for us.

One thing that the charts sure do show is that, at least as far as the oil market is concerned, the markets are not too impressed by the announcement of QE3. Our 6-month chart for Light Crude shows that it caved in last week, breaking down from the uptrend in force from early July, which was kicked off by the giant bull candle late in June that completed a two-day candlestick pattern known as a “bullish engulfing pattern”. The breakdown on Wednesday was on high volume, which is viewed as bearish, and the feeble recovery on Thursday and Friday is expected to be followed by renewed decline. The sharp breakdown is viewed as marking a reversal and the start of a downtrend in oil, so it would appear that the looming attack on Iran is “on the backburner” for now. The fundamentals of slowing global demand due to the gathering global depression may be about to take over, despite the speculative games being played by the banks with their Fed generated largesse.

The attack on Iran may not occur at all, if China and Russia make it sufficiently clear that it will lead to dire consequences. Having mopped up virtually the entire Mid-East, by invading Afghanistan and Iraq, and fomenting revolutions in what are considered to be rogue states, like Libya and Syria, there is one last large ripe fruit waiting to be harvested by Israel and US, and that is Iran, which is highly coveted. The ludicrous story about Iran acquiring nukes which they will then automatically use on Israel is reminiscent of the absurd “weapons of mass destruction” story put about concerning Iraq before it was invaded. This sort of story is only intended to provide a “fig leaf” excuse for the 60 to 70% of the population who are gullible and will believe anything. Once they have attained this ultimate goal of seizing Iran, they will have achieved complete suzerainty over the Mid-East and in the process neutered all states that are opposed to Israel, and of course they will have acquired dominion over the region’s still vast oil reserves. It will be very interesting to see if China and Russia stand by and watch Iran taken down, like they did Afghanistan and Iraq – now you know a big reason for the gargantuan US military machine.

Returning to the charts we can see that the oil market has actually been rather a bore for the past 3-years, as we can see on the 5-year chart for Light Crude. Adjusted for inflation we can see that it has hardly gone anywhere these past 3 years, as after its post-crash steep recovery move, it has essentially been stuck in a large trading range. While the swings within this trading range were wide enough to provide profit making opportunities for adept traders, it hasn’t been much of a story for investors. Given the dramatic slowdown in the global economy in recent months it is surprising that the price has held up as well as it has, and the reasons for this are investors salivating over the prospect of QE3, coupled with expectations of an attack on Iran. However, when QE3 was actually announced, oil sold off – not a good sign for the price going forward – and we can see from the MACD indicator at the bottom of the chart that momentum is starting to turn negative as oil marks out a series of descending tops.

Oil stocks have been in a gentle recovery uptrend since their 2008 – 2009 panic lows, that we can see on the 7-year chart for the XOI oil index, which included one notably impressive upleg from mid-2010 through early 2011, but since the peak in the Spring of 2011 the pattern has morphed into a large Symmetrical Triangle, indicating a state of indecision gripping the market. The course of this market going forward, as for the broad stockmarket, depends on whether the negative fallout on corporate profits from the global depression overwhelms the stock buying power of the big banks and Wall St itself, armed as they are with their big bag of cash generously printed up for them in perpetuity by the Fed, and other central banks around the world who are “seeing the light” and following the Fed’s example, like the European Central Bank. We don’t know the outcome to that and will be happy to let the markets declare themselves as they are expected to soon enough – and as we have seen, the oil market may already be starting to do so.

The audacious may want to short oil stocks here, as they are towards the top of their Triangle on the XOI index, in the expectation of this index dropping back down to the lower boundary of this Triangle, before possibly going on to break down from it. Traders who do this should maintain a stop above the upper Triangle boundary, and should remain aware of what could happen if there was a sudden attack on Iran – cheap Calls with high strikes are a good way to insure against this risk. However, as stated above, the behavior of the oil price suggests that the risk of an attack is low over the short to medium-term.

On the 6-month chart for the XOI oil stock index, everything looks pretty much OK – oil stocks showed remarkable resilience when oil plunged last week, holding up well, and are still quite some way from breaking down from their uptrend. On the face of it, just going on this chart, there appears to be little to fear – but the uptrend from the June low is getting “long in the tooth”, and the index has arrived at the larger trendline target shown on the long-term 7-year chart, so we should be on the lookout for a possible breakdown soon.

Last week’s breakdown by oil would not have come as much of a surprise to those following the COT structure – it was preceded by a big buildup in Commercial short and large Spec long positions, and, as we know, the Large Specs are specialists in getting it wrong – perhaps they were duped by the mainstream financial press into believing that an attack on Iran was imminent.

Finally, using candlestick analysis, the uptrend of the past several months in oil was called on the site the day after it started, as the following chart from that time shows.

The uptrend of the past several months in oil was kicked off by a massive white bull candle on big volume that broke oil decisively out the steep downtrend that it had been stuck in, and which “engulfed” the previous day’s black candle, hence the name “bullish engulfing pattern”. Whenever you see such a huge white candle appear after a lengthy downtrend that has led to a deeply oversold condition, and it is accompanied by big volume and results in a clear breakout, you can be pretty sure that it marks the start of a new uptrend.

Clive Maund
September 25th, 2012

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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