Assessing Crude After A Historic Drop

Last week, there was an example of why setting and sticking to stops, something I frequently stress, is so important.  On Friday, I wrote that it may be worth trying a very risky, long WTI trade given the proximity to the previously rock-solid $42 support level. If you did so, I hope that you read all the way through that piece and set a stop at $41.50. That was an important element of the trade, and would have been triggered, forcing a small loss before the collapse over the weekend. It is a classic case of a time when staying disciplined enough to hit a stop-loss turns a losing trade into something that feels like a win.

Whether you did or not, though, the massive gap that occurred over the weekend pushed WTI futures through that support and into a new range and the next question is, as it always is, where next?

The first thing to do is to identify what that new range might be.

Monday's historic collapse overshot the mark, as these things are wont to do, and hit a low of just below $28 before bouncing back. That bounce was also exaggerated, with WTI reaching just over $36 before settling back down. That leaves us with an effective range for now of $28-36.

As I write, the market is trading at $32 and change, right in the middle of that range.

The first thing to understand when trying to assess what next is that other than for very basic, broad-based things like identifying a possible range to work with, technical analysis is of limited value at a time like this. Crude pricing is being driven by headlines and is being battered by major shifts in the outlook for both supply and demand.

Right now, the supply side of the equation is dominating.

The collapse of the OPEC+ agreement in the face of the Russians' refusal to ratify the recent agreed upon increase to output cuts was followed by massive price cuts from Saudi Arabia. That is what caused Monday's collapse. The bounce was partly due to the natural overshooting of a big move but was also fueled by speculation that the two sides would meet and possibly rethink their initial reactions.

Even if they do, though, the cat is already out of the bag and the damage has been done.

The illusion of steadfastness and unity in the face of increasing U.S. shale production has been shattered, and even if some kind of agreement is reached, it is unlikely to have the level of trust in its efficacy that would be required to challenge the top of the new range, let alone erase the big losses.

On the demand side, of course, coronavirus is the issue.

That is a rapidly changing picture. As more data come in, it now looks as if this is indeed either more contagious or more deadly than the regular flu, and maybe even both. However, whether it is or not, as important as that is from a public health perspective, the seriousness of the disease is not the point when it comes to financial markets. What matters here is the extent of the reaction, and it is now clear that that is massive.

You may think that shutting everything down is a gross overreaction or just a sensible precaution, but either way, it will be a big blow to the global economy whatever the outcome of the disease itself. At the moment, with the oil market's focus on the supply side drama, that reality is not driving crude, but it is bound to factor in at some point.

It is clear then that the major risk, even from these depressed levels, is still to the downside. It could be that the massive drop this week has priced most of the bad news in already but even then, it is hard to see any serious upward momentum for crude in the near future. Meanwhile, the downside risk, should talks between Russia and Saudi Arabia not take place and/or the coronavirus panic escalates even further, is very real.

On balance, then, as tempting as playing a recover is in some ways, maintaining a short bias in oil for a while looks like the best strategy.