Crude Oil Looks Vulnerable

By: Seven_Days_Ahead

We have remained sidelined in Oil for quite some time now as we judged the market lacked long-term direction. Although a recovery began after the steep sell-off in May, we decided the subsequent rally was probably a correction rather than a resumption of the previous bull trend.

The Technical Trader’s view:

MONTHLY CONT. CHART The market is caught between the 50% Fibonacci retracement resistance at $90.28 of the pull back to the $40 level in 2008. And the support from the 38.2% Fibonacci retracement support at $66.71…. BUT note the monthly Key Reversal of last month. There has been no reaction to that so far, but we think it may yet…. Smashing down through the $66.71 support

The Macro Trader’s view:

The May 2010 sell off was driven primarily by a spike in risk aversion caused by what became the Euro zone Sovereign debt crisis. As traders began to fear a sovereign default all risky assets were dumped in favour of safe haven trades such as government bonds, the Dollar and Yen.

They reasoned that if a government of a developed economy defaulted the repercussions would be far and wide with growth a likely casualty. But even when the Euro zone finally launched its safety fund worth US$1.0T traders were not re-assured. Only when the budget austerity measures were adopted by virtually all Euro zone economies, including Germany and more recently France, did markets breathe a sigh of relief. The resultant rally in equity markets marked a drop in risk aversion and traders began to buy back into oil too.

But a collateral risk of the rush to fiscal consolidation is a growth pause or worse, a dip back into recession. Equity markets have begun to take this risk seriously and are once again looking vulnerable. The Oil market too is struggling for direction.

The oil price already looked extended to us before the sell off when confidence in the recovery was reasonably high. We thought the recovery was initially unlikely to be as robust as in previous recovery cycles and the overhang of oil supply that had built up during the economic downturn would take time to work off, meaning supply was likely to outstrip demand.

But now with traders worrying about the outlook for the Euro zone economic recovery, where will the extra demand needed to push the oil price higher come from?

Moreover, a big question mark has once again arisen over the US economic recovery. Traders were already nervous after recently weak non-farm payroll and retail sales. But housing market data released over the last two weeks has solidified those worries.

This week has seen the release of much weaker than expected Existing and New home Sales. It is now perfectly clear that the housing market was only being propped up by tax breaks which have now expired. If the strength of the US economic recovery is now in doubt, what then of the oil price?

For the oil market to test the highs, we judge fresh new evidence is required, showing the global economy is expanding faster than is currently the case, and we don’t think it will be forthcoming, at least in the short/medium term, so our attention has turned to downside trading opportunities in oil.

Mark Sturdy
John Lewis

Seven Days Ahead
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