Will Oil’s Upward Trend Hold?

Last week, I suggested a trade that bracketed crude, going long on a break above $70 or short should CL drop below $67. That worked out well as a break above $70 was followed by a surge to over $73. I made good money on that and I hope you did too, but now we have fallen back again, are in mid-channel once more, and I find myself looking around for inspiration.

I make a living by having opinions, both as a trader and as a writer, so it is not often that I give in and say I don't know where a market is headed. That, however, is the case with crude right now. The retreat from the July $76.98 high in CL looked for a while to be taking the form of a wide but conventional descending channel, then that all disappeared this week with the strong break back above $70. That move, however, couldn't be sustained, as crude has given back around 2% over the last couple of days. Now we are stuck in the middle of an unconfirmed upward trend and could break either way…

It is little wonder that the chart for CL is a bit confusing because the fundamental supply and demand picture that drives longer-term trends is itself unclear.

Supply is still somewhat restricted, as it has been all year. OPEC+ didn't reinstate the full output cuts as the Delta variant causes a global resurgence of Covid-19, but they did keep the current schedule of only gradual reinstatement of the emergency, pandemic prompted cuts. That means that while output is increasing, global supply remains tight. In some circumstances that would mean a massive jump in U.S. output to fill the gap, but that, unsurprisingly with a regulation minded, unsympathetic White House, hasn't come about.

The rig count has been climbing slowly, but has levelled off at around 400, way below 2019 levels. Add that to the recovery in demand and you have a broadly bullish environment, but if rig numbers start to increase again, that will turn quickly.

Supply is, as I said, tight, but it is pretty constant and predictable, so fundamental analysis right now is mainly about demand… and that is unusually hard to predict. The pandemic is still the main issue and there is no doubt that Covid is resurgent. Infections, however, are concentrated among the unvaccinated and there is a growing feeling among those who have had their shots that they are not prepared to endure restrictions or shutdowns to protect those that have chosen not to take them. The question therefore becomes whether politicians are prepared to impose unpopular restrictions for the sake of public health, and that is still uncertain.

If they are not, there is no doubt that demand is recovering quickly. It is already above pre-pandemic levels and with international travel yet to resume and the effects of the $3.5 trillion stimulus package still to be felt, there is some growth to come. That is why, long-term, I am still bullish on crude. However, markets are nervous right now, making a big "risk off" move in the next few weeks distinctly possible.

So, with the outlook overall unclear and no reliable technical signals available, now is not the time to trade aggressively in crude.

There are a couple of things that could change that picture. The first, and most obvious would be a meaningful reduction in Covid cases and/or an increase in the vaccination rate, both here in the States and internationally. As long as that situation remains the same though, there is still risk, so the other thing that could change the outlook is a change in the risk tolerance of global traders and investors.

That is why I am watching the stock and bond markets. The stock market is particularly interesting, with the S&P 500 sitting right around the 50-Day Simple Moving Average. If it breaks, and, based on history that would mean two consecutive closes below the level, it would be a serious sell signal for stocks. The MA (blue line on the chart below) has held an incredible eight times already this year, and a break below a support that strong would be a big risk off signal to other markets.

I am also watching 10-Year T-Note yields as an indicator of general risk appetite in the market. Treasuries are the "safe" asset for international investors and are where scared money hides when trouble is brewing. More money flowing to safety pushes Treasury prices up, and therefore yields down, so a move back below a yield of 1.3% would push me towards favoring shorts in crude for a while.

So, I am watching markets other than CL for clues as to direction, but I will also watch futures themselves. If we drop to the bottom of the new upward channel (marked in gold on the first chart) and that holds, a distinct new, bullish pattern will be confirmed. On the other hand, if we drift a little higher and stay in the middle of that channel, the outlook remains uncertain from a technical perspective.

This isn't the first time I have found myself to be undecided on crude. It happens regularly but, because of that, I have learned how to handle it. You must first recognize it for what it is, and then act accordingly. That means not trading just for the sake of it, but instead identifying things that will likely signal the next move and then tracking those things. Right now, those things are the S&P in relation to the 50 MA, bond yields, and the look of the 1-day candle chart for CL. Those are the things that energy traders and investors should be watching next week but until something changes, I for one will be sitting on my hands.