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Crude Oil Analysis for the Week of January 23, 2012

By FX Empire | Mon, 23 January 2012 01:36 | 0

Despite the shift in the fundamentals the week before, March Crude Oil failed to follow-through to the downside and the market finished the week with an inside range. This pattern typically indicates impending volatility since a market like crude oil seldom trades in a tight range two weeks in a row.

The main trend is up. This will be confirmed if the market can trade through the recent top at $103.90. This will reaffirm the uptrend, but the market may run into resistance at the downtrending Gann angle at $105.87. On the downside, a trade through the short-term uptrending Gann angle at $98.95 could be the first sign of lower markets to follow.

Looking at the bigger picture, the break through the last swing bottom at $92.95 will turn the main trend down. This will trigger a further decline into uptrending Gann angle support at $91.92. A trade through this level will lead to the retracement zone created by the $75.92 to $103.90 range. The key levels are the 50 and 61.8 percent prices at $89.91 and $86.61, respectively.

That’s the technical picture, but what will have to happen fundamentally to set it all in motion?  Last week’s lack of downside follow-through can be explained by the U.S. holiday shortened week and this week’s Lunar New Year holiday, but this only explains the light volume and the low volatility.

The tight range can best be explained by trader indecision. On one hand, the possible end to the Iranian embargo threat led to long liquidation. On the other, however, renewed demand for greater return may have fueled an interest in risky assets especially since stocks rose and the U.S. Dollar weakened. Oil speculators may have read the rise in stocks as a sign of an improving economy and therefore increased demand for crude oil. Furthermore, since crude oil is priced in U.S. Dollars, a weaker Greenback means cheaper oil prices. This too could lead to increased demand.

Since the futures market tends to discount future events, traders most likely were speculating last week that an improving economy and a weaker dollar would be good for crude oil prices. In order to prove to be a valid assessment of the crude oil market, this conclusion must begin to show up in the weekly crude oil inventory numbers or the oversupply will lead to a collapse in prices. This leads me to conclude that speculators are holding the uptrend intact.

Although fund managers may be committed slightly to the long-side of the market, they have to be maintaining their positions with trepidation. Thin trading because of the Asian holiday could lead to liquidity gaps which in turn may create whipsaw trading action. In addition, problems in Europe could flare up at anytime, wiping out all demand for risky assets. These scenarios best explain the limited upside action.

This brings us back to the supply and demand situation which should be the governing force behind all price action. At this time, weakening demand fundamentals still have a strong grip on the markets as evidenced by the top that was made two weeks ago. In addition, last week the U.S. Energy Information Administration reported that oil consumption in the U.S. in the last four weeks tumbled 7.2% from a year earlier.

Although there was demand for crude oil last week created by increased risk appetite, this was not the demand the market was looking for so at some point traders will have to face the reality that the fundamental supply and demand situation is deteriorating. Unless there is a pick-up in demand, it is unlikely that speculators will be able to sustain a rally, leading to my forecast for lower prices over the near-term.

Besides increased appetite for risk, speculation and the supply/demand outlook, the possible closing of the Strait of Hormuz remained in the news. The week before oil fell when Europe decided to reconsider an embargo of Iranian oil. Even with Europe softening its stance, the market still firmed when Iranian Ambassador Mohammad Khazaee said “There is no decision to block and close the Strait of Hormuz unless Iran is threatened seriously and somebody wants to tighten the noose.”  He further added that “All options are, or would be, on the table.” This comment appears to have done what it was intended to do, it stopped the oil decline.

In conclusion, traders should look for volatility next week as signaled by last week’s inside range. Baring any surprises regarding the oil supply out of Iran, a weak supply and demand situation should limit gains and keep downside pressure on the market. Increased risk demand led by strong stocks and a weaker Dollar could also limit downside pressure, but a deteriorating supply and demand situation should overcome any long speculative interest.

Factors Affecting Crude Oil This Week:

Supply and Demand: Last week’s supply and demand report showed a drop in supply. This was the first decline since the week-ended December 2nd. One down week does not change the trend so traders will be paying close attention to this week’s inventory number to see if there is a shift in the fundamentals.

European Sovereign Debt Crisis: Things have calmed down enough in Europe to warrant a reasonable short-covering rally in the Euro. This weakened the Dollar making commodities priced in dollars less expensive. Crude oil prices should work higher if the short-covering continues this week. On the other-hand, the situation in Europe is still dicey, meaning there is still room for further deterioration of the Euro and a collapse in demand for higher-yielding assets.

Geopolitical Events: The standoff with Iran appears to have softened so traders may begin to discount the occurrence of any military skirmish. Crude prices could drop if speculators decide the possibility of an embargo has been squashed. 

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