Despite crossing to the strong side of a long-term 50% level earlier in the week to extend the rally, the price action late in the week strongly suggests that March West Texas Intermediate crude oil may have finally found enough resistance and selling pressure to form a top and fuel the start of a short-term correction.
Since early December, crude oil has been on a tear as investors began to buy into the idea that the OPEC-led production cuts could tighten supply over the long-run. If you look at the timing of the price surge, however, you’ll notice that the breakout to the upside was largely fueled by a steep drop in the U.S. Dollar, which helped boost all dollar-denominated commodities like crude oil and gold.
Furthermore, exchange statistics show that hedge funds and other large speculators had been taking on huge long positions, providing the upside momentum the market needed to sustain the rally.
Along the way, the rally was further underpinned by a pipeline shutdown in the North Sea and a pipeline explosion in Libya.
Seven consecutive weeks of drawdowns in U.S. crude oil supply have also had a positive influence on prices.
The plethora of bullish news gave the hedge funds the confidence to continue to build on their long positions week after week despite lingering worries over increasing U.S. production. Hedge fund willingness to buy strength drove the upside momentum into multi-year highs. Traders weren’t playing for dips in the market. They firmly believed in the bullish long-term fundamentals and their ability to take this market higher throughout the year.
The hedge funds interpreted the fundamentals correctly, however, their aggressive buying and their willingness to buy strength may have overheated the market enough to force new buyers to the sidelines. Once traders stopped buying strength, this sent a signal to traders that the market may be ripe for a short-term correction. And that is what we’re seeing this week.
Early this week, a euphoria seemed to hit the crude oil market as the big banks started to come out with their price forecasts. Bank of America Merrill Lynch and Morgan Stanley raised forecasts for oil prices in 2018, while Goldman Sachs said there is growing risk that it will have to push up its targets.
Unfortunately for bullish traders, the commentary from the banks was not enough to fuel another surge to the upside. The reaction to their bullish assessments of the crude oil market seemingly turned into a “buy the rumor, sell the fact” situation.
Throughout the week traders began to raise concerns about a potential increase in U.S. oil rigs, a possible oversold U.S. Dollar and expectations of rising U.S. production.
After straddling the long-term 50% level most of the week, WTI prices finally started to break after the U.S. Energy Information Administration announced a rebound in U.S. production during the week-ended January 12. According to the EIA, U.S. crude oil production stood at 9.75 million barrels per day (bpd).
The selling pressure strengthened after the International Energy Agency (IEA), in its monthly report, warned that rapidly increasing production in the United States could threaten market balancing.
“Explosive growth in the U.S. and substantial gains in Canada and Brazil will far outweigh potentially steep declines in Venezuela and Mexico,” the IEA said of 2018 production.
Weekly Technical Analysis
(Click to enlarge)
The main trend is up according to the weekly swing chart. The trend is in no danger of turning lower, but it is in a position to form a potentially bearish closing price reversal top this week.
Given the prolonged move up in terms of price and time, the market’s reaction to the major, long-term 50% level at $64.11 and the steep uptrending Gann angle at $64.07, a close below last week’s close at $64.23 will form a closing price reversal top.
A confirmation of the chart pattern next week could fuel the start of a 2 to 3 week correction. In the worst case scenario for the bullish traders, the potential downside targets will be the uptrending Gann angle at $57.57 and the 50% level at $57.41.
Daily Technical Analysis
(Click to enlarge)
The daily chart is showing a similar chart pattern. The main trend is up, but it formed a closing price reversal top at $64.74 on January 16. The confirmation of the chart pattern helped trigger a further decline to $62.78 as of Friday.
The main range is $56.07 to $64.74. Its retracement zone is $60.40 to $59.38. This zone is the primary downside target.
The rare combination of a daily/weekly closing price reversal top is enough to convince me that the selling is greater than the buying at current price levels. Keep in mind that the chart patterns are not indicating the trend is changing, but due for a short-term correction. The move is designed to shake the tree a little and alleviate some of the upside pressure by forcing out the weaker longs.
The retracement zones are also value zones. Given the uptrend, a pullback into the retracement zone on the daily chart at $60.40 to $59.38 is likely to draw the attention of new buyers.
The size and duration of the short-term correction will be determined by the aggressiveness of the hedge funds. If they just want to lighten up their long positions and book a little cash along the way then the sell-off will be neat and orderly.
If they want out of the market completely then they’ll sell with both hands, in other words, more aggressively.