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Oil Market Update

Clive Maund
October 14, 2008

Remember all that talk about Peak Oil? - it peaked alright back in July and has been in a severe downtrend ever since that has resulted in it dropping in price by nearly a half. Late last week it finally broke down from the large Head-and-Shoulders top area that we had earlier identified at the summit of the Right Shoulder to confirm that a major bear market now exists in oil. While this signal is clearly very late and probably of little use to the trader who bought near the top, it still has important forecasting implications going forward.

On the 2-year chart we can see the large, irregular Head-and-Shoulders top and how the price broke down below the neckline of the pattern at about $85.50 just last week. The reason that it fell so much on Friday was the breach of the important support towards and at the neckline. The measuring implications of the pattern point to a further heavy decline towards $50.

Oil is now deeply oversold however after the prolonged and severe downtrend of recent months, as can be seen by reference to the MACD indicator on both the 2-year and the long-term chart, with the latter revealing other factors suggesting that a bounce is likely very soon before it continues to lower levels. These include the fact that oil has dropped back to an important support level and also to the lower support line of its long-term uptrend in force from late 2001.

There are 2 very bearish fundamental factors in play that have been responsible for the severe downtrend in oil and which to continue to drive the price lower. One is the prospect of severe recession/depression, which would result in a sizeable reduction in demand for oil. The other is efforts to weaken Russia. Russia is considered by The West generally and NATO and the US in particular to have been "getting too big for its boots", especially after its recent actions in Georgia. As Russia is a major producer of oil, oil revenues are a prime source of Russia's economic and military power. This being so the way to weaken it is to lower the price of oil. This presents a moral dilemma for the US Republican party, for while on the one hand it would obviously like to lower the oil price for the purpose of weakening Russia, extensive crony connections with the oil industry have been and are a powerful incentive to do just the opposite. With regard to the latter motivation, the Bush Administration can congratulate itself on a job well done, having presided over a rise in the price of oil from about $18 late in 2001 to nearly $150 last July, which has of course resulted in huge windfall profits for the oil industry regardless of the later drop in price.

With The Old Guy slipping in the polls, partly it seems because of stories about Wonder Woman Sarah Palin having used her power to have someone kicked out of their job when she was Governor of Alaska, it is looking increasingly likely that Barrack Obama will become the next President of the United States. If so he will go down in history as the biggest bagholder of all time - as nobody in history has ever been confronted with a bigger mess. While the plutocrats who control both the Democratic and Republican parties don't much care which of them is elected, it is clearly better for the oil industry to have the Republicans in power. The loss of many of their friends in high places when the Republicans are kicked out is another factor expected to weigh on the sector.

The interpretation of the pattern in the OIX oil stock index in the last update as a bearish Flat-bottomed Broadening Formation proved to be correct as once the bottom support line of the pattern failed, oil stocks went into crash mode. We can see they have disappeared over a cliff on the 2-year OIX oil stock index chart. At this point they are critically oversold and due a snapback rally which could be significant, especially as at the time of writing, Sunday night, it appears that the politicians have had a relatively fruitful weekend by their standards, and have actually hit upon the idea of guaranteeing interbank lending, although whether this is workable is something we will try to figure out later. In any event, if the market believes it is, or even hopes it is, we could see a sizeable bounce in the broad market which would create the background conditions for some sort of recovery rally in oil stocks. Longer-term the outlook for both oil and oil stocks remains bearish.

Clive Maund

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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