Crude Oil Outlook
February Crude Oil futures have been drifting sideways since reaching a new contract low at $53.94 on December 16. Although the major fundamentals remain bearish, oversold technical factors may be helping to contribute to the current price action.
There may also be some activity going on behind closed doors between the Saudis and the other OPEC nations that could be underpinning the market, or the cause of the sideways action may be end-of-the-year book squaring by commercial traders or the hedge funds.
Because of the thin holiday trading conditions, we are not likely to know if this sideways action is indicative of bottoming action or just a temporary stop on the way to $50, $40 or even $35 a barrel crude oil.
The downtrend is relatively easy to see on the charts and the fundamentals are simple to understand. When this occurs, trend traders and non-professionals tend to jump in to go along for the ride. The problem with this is that these types of market players often become complacent because they are making money too easily and feel they don’t have to babysit their positions as closely as they would under normal two-sided trading conditions.
If this is occurring then the market will become susceptible to short-covering rallies. One way this sell-off is going to end at least in the short run is when the major shorts begin to cover. The other way is when the hedge and commodity funds run out of bottom-pickers to sell to. The current price activity suggests consolidation may be taking place. This is usually a precursor to the start of a short-covering rally and the holiday season is probably the best time to start one because it is usually dominated by thin trading conditions.
From a technical analysis and a counter-trend trader perspective, this market is set up for a strong short-covering rally. From a fundamental perspective, the supply conditions remain bearish. I suspect that although the fundamentals are bearish, this market may rally into the end of the year because of profit-taking and to set up the next shorting opportunity.
If you are a short-term trader then you will probably welcome a two-sided trade. If you are a nervous trader then you are probably hoping to find any excuse to book profits. Finally, if you are a fundamental trader, you probably want to see a short-term rally so that you can re-enter the market on the short-side at a more favorable price level.
Longer-term traders don’t have a lot to worry about until there is a dramatic shift in the fundamental news. Factors to watch include a drop in output by U.S. producers. This will usually show up in the number of drills operating. The change in the fundamentals that will have the largest influence on the market will be a cut in production by OPEC.
Recently, it has been rumored that Non-OPEC countries have been pressuring the Saudi’s to agree to a price cut. This may be another reason for this week’s stabilized trade. This is the type of activity that usually occurs behind closed doors, however, it may begin to show up in the charts. At this time, even if you are a staunch fundamental trader, it is suggested you watch the chart pattern for signs of consolidation and short-covering.
Bearish traders especially should watch the chart pattern for signs of a short-term bottom because the daily chart indicates there is plenty of room to the upside to retrace. At this time, one of the best things to do is assess the odds of breaking another $10 or $15 lower versus a 50% retracement of the break from $76.69 to $43.94 or a move back to $60.31.
If you’re speculating and can withstand a move back to $60.31 then stay with the trade. If your objective is to book profits then consider tightening up your buy stops. If you need to hedge then the current price action suggests now may be a good time to lock in these favorable prices.
In summary, clearly the fundamentals are bearish, but it is often said by traders that the technical action precedes the fundamentals. We could be looking at that situation right now where the technical indicators are saying “we’ve run out of sellers and may need to rally”. My suggestion if you are short is to trade defensively at current price levels until we get through the holiday season and normal trading activity returns.