The 12-week crude oil rally appears to be running out of steam after reaching $98.24. Despite the close near the high last week, buyers were absent from the get-go this week as the market opened on its high and proceeded to break sharply. At the finish on February 1, conventional technical analysis tools such as the Relative Strength Index and Stochastic Oscillator indicated overbought conditions.
These conditions may have tripped technical selling programs, encouraging non-discretionary money managers to begin liquidating their long positions. As of January 29, the Commitment of Traders report had showed large positions held by money managers so with buyers drying up at current price levels, their reaction was to begin paring positions.
The Commitment of Traders report also showed an increase in short positions by commercial traders. This was an indication of new hedge positions as these large players decided to lock in prices after the lofty rally from the November bottom at $85.40.
Although the supply and demand situation had been suggesting for weeks that a top was imminent, speculators continued to drive the market higher because of the perception of an improving economy. The rapid rise in the global equity markets since the first of the year combined with the recent ascent of the Euro contributed to increased demand for higher risk assets.
This week’s sideways-to-lower action in the major stock indices coupled with a sharp drop in the Euro are two reasons why crude oil is feeling downside pressure. Stock traders are starting to realize that equities are overpriced and a correction may be imminent to bring equities back to value areas. On February 7, European Central Bank President Mario Draghi commented that the central bank may have to monitor the effect of the Euro rally on price stability.
Both of these factors are contributing to the weakness in crude oil because they encouraged investors to move money into the U.S. Dollar for safety. Since crude oil is dollar-based, it quickly became more expensive for foreign investors. This action is likely to be confirmed next week when the Commodity Futures Trading Commission releases its fresh Commitment of Traders Report.
Technically, the weekly chart indicates there is plenty of room to the downside. Based on the rally from $85.40 to $98.24, the major downside target is a 50% price level at $91.82. Resistance comes in at $97.03 the week-ending February 15. Support moves up slightly above the 50% price at $92.10.