A lot of people have got very excited as the price of WTI has bounced back from the lows reached a few months ago. If oil fails to break and hold above $62 this time around, however, their enthusiasm could well be misplaced, as the fundamental factors that caused the price decline in the first instance are still in place.
That, combined with the technical importance of this challenge of the resistance, makes a drop back below $50 look more likely than a continued rally. When short-term technical indicators and long-term fundamentals both suggest a move in the same direction, as is the case here, investors are well advised to pay attention.
In the short term, as the above 3 month chart clearly shows, the $62 resistance level that we are approaching again has enormous significance. Most traders will tell you that the third attempt at a support or resistance level is the most important, and the reason for that is also clear on the chart.
The first time WTI tested $62 it dropped back to around $60 when momentum reversed. Then, a few weeks later, failure to break through led to a more pronounced retreat, back down to around $58. Each failure to break above a resistance point usually results in a bigger correction back the other way, so failure on the third try would likely be followed by a drop to $55-56, making another attempt far less manageable. From there the combative nature of traders would make a re-test of the January lows more likely.
The real problem, of course, is the same one that is always faced by technical analysis…price doesn’t exist in a vacuum. There are real world fundamental factors that are far more influential. With oil, those fundamentals also suggest another drop is coming.
Part of the reason for the rally was just that the initial move was so fast and furious that a correction was inevitable. That came in large part at the beginning of the year, when the dollar stopped its seemingly inexorable rise and began to retreat.
Oil is priced in dollars, so, all else being equal, if the dollar is worth less then, on a relative basis, oil is worth more and the price goes up. Just as with the commodity, however, the reversal in the currency markets looks more like a temporary correction than a true change of direction when the fundamental factors that caused the initial move are considered. Related: Goldman Sachs Predicting $45 Oil By October
Two of the U.S.’s major trading partners, the Euro zone and Japan are still pursuing QE of sorts, long after the Fed has wound down the policy here. Whatever you call this type of policy, it is basically liquidity creation also known as printing money. Anybody who has taken economics 101 can tell you that increasing the supply of something will decrease its value relative to other things. Relative dollar strength, therefore is a result of the most basic of fundamentals, supply and demand.
Oil has its own supply and demand issues too. The increased domestic supply of oil as fracking wells really came online, along with fears of slowing global growth and falling demand for fossil fuels, were major factors in oil’s collapse. Nothing much has changed there either. On the demand side there has been no global meltdown but China is still weaker than expected and recent U.S. GDP numbers have been disappointing. The developed world continues to become more energy efficient. Related: Oil Prices Will Fall: A Lesson In Gravity
Even the good news on the supply side looks a little suspect. The recent move up was sparked by lower U.S. oil production numbers, but analysis suggests that it was a temporary slowdown in Alaska, not a reduction in fracking production, that caused the rise. Inventories still remain elevated and Saudi exports were the highest since 2005.
In short then, it looks like the things that caused the dramatic fall in WTI, oversupply, a risk of falling demand and a strong dollar are still with us. This test of $62 looks doomed to failure and a return to below $50 seems almost inevitable.
By Martin Tillier of Oilprice.com
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