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Oil Market Update

Clive Maund
November 2nd, 2014

You've seen what happened to gold and silver last week - they crashed support and plunged. Well, the same looks like it's about to happen to oil, one reason being the same, the strong dollar, and the other reason being sagging demand as deflationary forces wreak havoc in Europe and other places.

On the 6-month chart for Light Crude we can see that after a steep drop during the 1st half of October, an increasingly tight trading range has developed that has all the attributes of a bear Pennant. This pattern, which has allowed the oversold condition to partially unwind, implies another steep drop dead ahead, at least of equal magnitude to the drop leading into the Pennant, and probably worse, for reasons that we will now examine on the long-term chart. The fact that it is still oversold on its MACD and relative to its moving averages won't spare it - it is likely to plunge as the dollar continues to advance.

On the 10-year Light Crude chart we can see that it is perched just above important support at its 2011 and 2012 lows, just above which the Pennant has formed. If this support fails it will confirm all of the action from early 2009 as the B wave of a giant A-B-C pattern, in other words just a great big bearmarket rally, and oil could really crater in a devastating C-wave plunge, with the $50 - $60 area being a modest downside objective. If this happens fracking and oil shale production in the US will be threatened with being consigned to the dustbin of history at least for the foreseeable future, which will at least be good for the environment. Deflation can be so unforgiving.

What about another massive round of QE to forestall such a drop in the oil price and make everyone happy? The problem is that to increase demand, consumers' pay increases have to outstrip inflation. It's no good just doing QE and then letting the banks hog all the cash and sit on it, you have to get out there and give it to the people. It is suggested that government representatives bypass the banks and get out there and give money to the people - they could drive around neighbourhoods in armored Brinks type trucks, calling door to door and giving families suitcases of cash - this would really get the economy moving - but they aren't going to do that, are they? - OK - so they had better get used to the effects of deflation, and a big one is a falling oil price.

Oil's COT structure has certainly improved significantly in recent months, with Commercial short and Large Spec long positions scaling back substantially, but this is not going to save the oil price in adverse market conditions, just as silver's seemingly bullish COT structure did not save it from its recent pummeling. It could get a lot better if oil suffers further heavy losses.

Click on chart to popup a larger clearer version.

Oil stocks have so far been partially cushioned from the effects of a falling oil price as they have been riding on the coat tails of the endlessly rising broad stockmarket, but the next hit to the oil price should really take the wind out of their sails, and send them reeling, especially as the broad market looks due for a rest after its recent strong recovery. On the 6-month chart for the XOI oil index we can see that although they did get hit quite hard during the first half of October, they have staged a substantial countertrend recovery during the 2nd half of the month, wafted higher by the rising stockmarket - but notice that oil itself made no such recovery. If oil now breaks lower, as it is expected to, oil stocks are likely to get slammed.

On the 10-year chart for the XOI oil index we can see the reasons why it bounced strongly during the 2nd half of October, despite oil not doing likewise. In addition to being goaded higher by the vertically ascending broad market, this index had arrived at an important support level not far above a major uptrend support line. That saved it and caused it to reverse, but another severe downleg in oil, which is what we are expecting, is likely to cause it to crash this support and break down from the uptrend, whereupon its rate of decline is likely to accelerate. This therefore looks like an excellent point to offload any oil stocks that you may still have, and while it also looks like a good point to short them, it is considered safer and more effective to short oil itself or buy oil bear ETFs , due to the recent outperformance of oil stocks relative to oil itself. The entire rally from the 2009 low in the XOI index looks like a bearish Rising Wedge, which fits with our interpretation of the all of the action in Light Crude itself from early 2009 as being the big B wave of a giant A-B-C waveform, that should be followed by a devastating C-wave plunge which may be starting now.

Conclusion - it looks like a really severe downwave is about to hit the oil sector, that will have profound ramifications both economically and politically. We will be looking at ways to capitalize on this expected development on the site.

Clive Maund
November 2nd, 2014

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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