Last week it was mentioned that nearby crude oil was expected to complete a test of the retracement zone at $92.37 to $90.85 and likely stay in this zone until the fundamental traders could reassess the economic conditions. After initially testing the 50% level at $92.37, the market fell further into the zone to $91.92 before establishing short-term support on the daily chart.
Despite the sharp sell-off from $98.79, the main trend is up. Since the break from the top is holding inside the retracement zone, one has to conclude that crude oil is in a corrective mode. Typically, this type of break is triggered by uncertainty. Bullish traders tend to lose their focus and begin to search for excuses to pare positions. This usually means a short-term break into more attractive price levels.
Some of the fundamental reasons for the recent weakness are commercial hedging pressure, a sluggish economy, and lower demand for higher risk assets. One clue that the market was nearing a top was a shift to the short-side of the market by commercial traders according to the Commitment of Traders Report. This was followed by speculation that the economy was at a standstill because of persistent rumors about flat gross domestic production. Finally, turmoil in the Euro Zone and talk of ending the Fed’s bond-buying program drove investors into the safety of the U.S. Dollar.
All three of these factors were relevant to the weakness exhibited in the crude oil futures market throughout February. These three elements are also going to be present during March. Although short-term oversold conditions could trigger a near-term retracement back to $95.36 to $96.17, the market will not be out of the woods unless the move is supported by fresh long positions and the paring of short-positions by the commercial traders. If they continue to press the short side then prices are likely to move lower.
Persistent rumors of a weakening economy came to fruition on Thursday, February 28 when the U.S. released its weaker-than-expected fourth quarter GDP report. This coupled with the mandatory spending cuts expected to take place on March 1 could bring an air of uncertainty to the market since some economists are projecting slower growth. This may be translated into lower demand for crude oil.
Finally, although Federal Reserve Chairman Ben Bernanke stood by the central bank’s bond-purchasing program, crude oil did not rally on the news despite a huge rebound in the equity markets. With crude oil seemingly divorcing itself from the equity complex and demand for higher risk assets, it looks as if prices are going to remain low over the near-term.
Problems in the Euro Zone and the fear of a rekindling of the Euro Zone Crisis could also have a negative effect on crude prices if it drives up demand for the U.S. Dollar. A rise in the Greenback will make crude oil more expensive for foreign traders and thus lead to lower demand.
To recap the technical picture, Nearby crude oil has entered a potential support zone at $92.37 to $90.85. This zone typically attracts fresh buying so bullish traders should watch for possible buying action since the market has reached a value area. Since the market is still going down, it doesn’t make sense for speculators to try to pick a bottom until short-term momentum on the daily chart starts to show a shift in sentiment. It may not be possible to pick the exact low, but re-establishing support at $92.37 could be a strong sign that a final bottom has been reached.