The Pressures on Crude Oil

By: Seven_Days_Ahead

Since the sharp sell-off back in May at the height of the Euro zone sovereign debt crisis, oil has experienced a long slow recovery, which for most of that time looked like no more than a prolonged period of sideways trading.

The Technical Trader’s view:

MONTHLY CHART The very long term support around the $40 level provided the bounce from the lows in early 2009.

The Macro Trader’s view:

For most of that period we were square of the market, but anticipated a fresh break down through May’s lows. And although the hysteria around the Euro zone crisis began to subside, fears of a US economic slowdown began to intensify, which led us to maintain an underlying bearish view of the market.

But oil has proved surprisingly resilient. Although the US recovery is still causing concern among policy makers, as data continues to slow led by weak housing and Labour markets, the Euro zone economy has began to strengthen, led by a resurgent German economy. While some of this new strength may be due to the earlier sharp sell-off experienced by the Euro, which it has since substantially retraced, something more durable seems underway in the German economy.

Add in the continued vigour of the Chinese and Indian economies and an argument for solid support underpinning this market can be found. But what has driven the market back through the $80 level? And why are even further gains now looking possible?

Clearly, strong demand for energy resulting from a strong recovery would be an important driver in a bull market, but with the US economy struggling for traction, that cannot currently be the reason.  Look instead at the weak Dollar.

At times of Dollar weakness, oil has historically rallied. This might sound paradoxical since a weak Dollar is ultimately a reflection of a weak US economy, but nonetheless, periods of extreme or extended Dollar weakness have helped oil rally because oil is priced in Dollars, and the value of revenue flowing to producers is effectively cut as the Dollar weakens. And as the period of Dollar weakness extends, producers begin to production cuts to force the price higher, and traders anticipate this by buying in the futures market.

Of course Dollar revenues from the US are unaffected, but from the rest of the global economy they are and since Oil producers are consumers with most of what they buy being imported, especially luxury goods like Mercedes Benz cars etc, a weak Dollar is like a pay cut.

So we believe Oil can rally further from here.

The engine for that rally will be either a return to stronger growth in the US or failing that, further Dollar weakness. Currently, the later looks most likely as data from the US continues to disappoint.

You might then conclude that oil looks a bull market no matter what happens, so why did it sell off during the financial crisis? Clearly a global recession, like the one recently experienced is a big negative for oil, regardless of the Dollar’s direction as energy demand slumps, but with two thirds of the global economy expanding smartly and the other third, the US bit, expanding slowly, Oil is a market that can be squeezed higher, as geopolitical concerns also have a significant role in this market.

Mark Sturdy
John Lewis

Seven Days Ahead
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Mark Sturdy, John Lewis & Philip Allwright, write exclusively for Seven Days Ahead a regulated financial advisor selling professional-level technical and macro analysis and high-performing trade recommendations with detailed risk control for banks, hedge funds, and expert private investors around the world. Check out our subscriptions.

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