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Jim Hyerczyk

Jim Hyerczyk

Fundamental and technical analyst with 30 years experience.

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Price Action Suggests Bullish Investor Sentiment

The price action by August Crude Oil futures is once again suggesting a balanced market. The low to high price action for the week suggests volatility, but the top to bottom action since May 6 indicates a balanced market and a sideways trade. This assessment could change significantly over the next several weeks if demand continues to increase at its current rate.

The market posted a strong rally last week, even taking out the previous week’s high at $61.83 before settling inside a 50% to 61.8% retracement zone. The actual bottom of the current upswing came in on June 5. The lack of surprises in last week’s OPEC announcement helped fuel a rally from $57.21 to $62.22.

OPEC said in its announcement that it would maintain its production targets at 30 million barrels per day through at least November. This is what traders were looking for so the announcement offered no surprises. Instead it turned into a “sell the rumor, buy the fact” situation. This type of price action appears quite frequently in the futures markets because they are highly speculative by nature.

The first rally from the $57.21 low on June 5 may have been fueled by short-covering, but buyers eventually jumped in to drive the market higher because of a decline in the U.S. dollar and the release of a bullish inventories report.

The Energy Information Administration said in its weekly inventories report for the week-ended June 5 that crude inventories declined 6.8 million barrels. This was the largest weekly drawdown since the week-ending July 11, 2014. Traders had priced in a 1.7 million barrel drawdown. The demand was also significantly higher than the five-year average withdrawal of 1.1 million barrels. The drop in inventory also marked the sixth straight week of drawdowns.

Although total inventories still remain historically high, the six weeks of withdrawals have helped to narrow the surplus. The drawdown in surplus has finally become relevant enough for traders to sit up and take notice. Just like the slashing of producing rigs, the pace of the surplus decline is beginning to pick up steam. This may be enough to create further upside momentum in prices.

Currently, there are 471 million barrels in storage. This puts the surplus at about 92 million barrels, about 24% above the five-year average. The significant development is that the surplus is now about 19% from the inventory peak in April. The current average rate of contraction suggests the market is likely to reach average levels in early 2016. This news is significant enough to create a floor for prices at around the $50.00 level, but not strong enough to suggest a rally much beyond the $75.00 barrier. 

(Click to enlarge)

Given what we know about the fundamentals and projecting it on a chart, this suggests that there is plenty of room to the upside if demand continues at its current pace.

The elongated price base that has been forming since late January may provide enough support to trigger a retracement of the sell-off from the early July 2014 top to the bottom the week-ending January 30.

This week’s rally has produced a new higher bottom at $56.88. It also showed that buyers were willing to take positions earlier than expected instead of waiting for a pullback into the short-term retracement zone at $56.42 to $54.60.

The support base also shows that, in terms of price and time, the rallies are getting longer and the breaks are getting shorter. This is usually a sign of aggressive buying.

If demand continues at its current pace then consider the following scenario. The main range is $96.78 to $48.71. Its retracement zone at $72.75 to $78.42 is the primary upside target.

According to the weekly swing chart, crude oil rallied from $48.71 to $64.12 from the week-ending March 20 to the week-ending May 8, or $15.41 in 7 weeks. If $56.88 is the new bottom then based on the previous swing rally, the new target is $72.29 by the week-ending July 17.

Just matching the previous rally will put the market fairly close to the 50% level of the main range at $72.75. If the rallies continue to increase in terms of price and time, then crude oil could easily reach the target zone identified as $72.75 to $78.42.

The price action this week suggests a shift in investor sentiment back to bullish. Speculators who recognized the increasing demand jumped in the market early at $56.88. If momentum continues to increase to the upside then look for a test of the recent top at $64.12. This price is the potential trigger point that will fuel an acceleration to the upside to at least $72.29 to $72.75 by mid-July.

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