This Drop In Oil Prices Is Only The Beginning

Okay, I finally get to say it! It has been a big, interesting week for crude oil!

After months of essentially range trading, with the main WTI futures contract, CL, staying within a narrow, slightly upward sloping channel, we have finally seen some directional action over the last three days.

Cl, after a failed attempt on Wednesday, broke down through the 50-Day Moving Average (MA) yesterday. From there, anybody who understands the mentality of institutional traders could have told you that an attempt at the trend line that marks the bottom of the channel was next. Sure enough, that came before the end of the day.

That attempt, however, failed initially. CL hit a low of $40.22, right on the line, before a rapid bounce led to a close at $41.28. The question for traders and, given the overall importance of crude futures in the sector, all energy investors, is does this signal the beginning of a significant move down, or does the support hold and therefore emerge even stronger?

From a technical perspective, the fact that as I write, CL is once again challenging that trend line suggests that it could break soon, but it is the circumstances of this morning’s weakness that seem to give the best clue as to what to expect from here. It is coming after the Bureau of Labor Statistics (BLS) Monthly Jobs Report for August showed an increase of nearly 1.4 million in non-farm payrolls and a drop in the unemployment rate, from 10.2% to 8.4%.

That is, or should be, great news for demand in the U.S., so one might expect oil to climb on that data. What we have seen though is this…a sustained selloff that, after a brief pause right around the support level, is looking increasingly like a solid breakout.

Of course, there is still a long way to go before the end of the day, but with a holiday weekend coming up in the U.S., that chart looks pretty perilous to me.

As I said, that is especially true when you put that move in context. Crude’s declines started on Wednesday, when the Fed’s Beige Book, its collection of the regional Fed Chairs’ impressions of the economy, sounded a distinct warning. Many of those regional chairs pointed to stubborn weakness in economic activity and the labor market in their regions, suggesting that the economic recovery on Main Street may be nowhere near as robust as Wall Street has been anticipating.

Then, yesterday morning, that selling in CL accelerated after a weekly jobs report that, when adjusted for a different method of adjusting for seasonality, showed an increase in unemployment claims. The inherent volatility in weekly data always makes it dangerous to read too much into that one report, but any increase in the numbers of unemployed at a time when we are supposed to be bouncing back strongly indicates once again that the rapid bounce scenario may not be playing out. That is understandably worrying for traders in a commodity as demand sensitive as oil, so yesterday’s big drop was easily explained.

This morning is a different story. Another dramatic decline following what looks like some good data hints at an underlying weakness that goes way beyond the technical. When traders completely ignore news that should contradict an ongoing move it is usually a sign that that move has some way to go, so, all things considered, this drop in oil looks like it could be just beginning.