Trading Crude With A Short Bias

In the last week of April, I wrote in these pages that even though the chart for crude futures (CL) was flashing a buy signal, fundamental factors had a bearish tone. As a result, I said that I would be trading with a short bias, looking for a pullback to the mi-$60s. That level was hit just four trading days later…

Then, in mid-May, when the market barely reacted to the news that the US was buying to replenish the Strategic Petroleum Reserve (SPR), I again took a bearish stance. Nothing had changed then in terms of the fundamentals. US supply was still increasing, reaching near pre-pandemic levels, and there was still a lot of uncertainty about the future of the global economy. This week has seen more news that could be considered positive for oil prices being pretty much ignored, and once again that lack of a reaction speaks volumes.

When I mention positive news for oil I am talking about things like a new phase in the Russian war on Ukraine, where Ukraine is now successfully attacking strategic targets deep inside Russia, including a drone attack on Moscow. The oil embargo placed on Russia by most Western nations following the invasion of Ukraine has proven so far to be ineffective, with Russian oil still hitting the market, albeit at a discount. But, if drones can hit Moscow, then oil facilities and pipelines should be reachable too, making a real disruption of supply possible.  

Then there is increasing evidence, including from Thursday's ADP jobs data, that the American economy is actually holding up quite well in the face of interest rate hikes, and monthly US crude production numbers that suggest that output has plateaued at best. All of that should be bullish, but crude is still trending lower this week and, if anything, a break below the mid-$60s low looks like the most likely next move.

The thing is, despite what looks like bullish news, the bearish fundamental influences have, if anything, intensified. The supply situation may be tightening for the reasons stated, but the next few months for oil aren't about supply. They are about the very real threat of a significant slowdown, maybe even a recession, in much of the developed Western world. If it comes, that will be a slowdown deliberately engineered by central banks in an attempt to control inflation, so data and news should always be looked at in terms of their interpretation by the Fed, the BOE, the ECB, et al and the impact on further rate hikes.

In that context, a higher-than-expected number of private sector jobs in America and other evidence of the resilience of the US economy are not positives for oil at all. They call into question the widespread assumption that the Fed will stop hiking rates this month, or at least announce a "pause" in rate increases. If the jobs market is still tight, and we will know a lot more about that when the May jobs report is released and digested on Friday, pausing rate hikes at this point could be seen by the Fed as dangerous, risking undoing the good done so far in slowing price rises. That may be why, already this week, two Fed board members have talked about "skipping" a rate hike this month, rather than pausing or ending increases.

At this point, for those not familiar with my terminology, I should explain what I mean by "trading with a short bias". That doesn't mean that I won't take intraday long positions when the technical signals suggest it. It just means that when I do, I will stick rigidly to stop-loss and take-profit levels, and make sure to square up by day's end no matter how the position is faring. Intraday shorts, however, are far more flexible, with target levels for winning positions being more about a rethink than a hard closeout. I will always be looking to either take a partial profit on a short, or simply reset the stop-loss so that I make at least a small profit overall, then run the remaining position, possibly for multiple days.

That allows for the possibility that I could be wrong; that the Fed could decide to signal the end to rate hikes, or that Russian oil supply remains intact, or any one of a number of other things that could push oil higher. If, on the other hand, I am right and the demand expectations for oil fade in the summer, the chances are I will be in a place to take advantage of that, without adding a ton of risk.