Too Much Oil, Not Enough Cold For The Markets

Crude Oil Outlook

A valiant attempt to consolidate March Crude Oil prices failed this week when the market traded down to a level not seen since April 2009.

The market has been particularly sensitive to recent U.S. economic data including Thursday's friendly U.S. weekly jobless claims, but when it was all said and done, the short-covering couldn't overcome the selling pressure especially since this week's government energy stocks report was so bearish.

The jobs data gave hope to traders who were betting the U.S. economic recovery would gather enough strength to promote demand for oil products. The jobless claims report was not strong enough to overcome the bearish supply data from the weekly U.S. Energy Information Administration (EIA) report which showed that domestic crude stocks had risen by almost 9 million barrels from last week to nearly 407 million. This is the highest level since the government began keeping such records in 1982.

The size of the short positions in the market reflects speculation that traders expect stockpiles to continue to keep building as U.S. production has shown no signs of slowing despite industry layoffs and decisions to curtail future projects.

Currently traders have an added incentive to continue to push prices of nearby futures markets lower because of contango pricing. This occurs when nearby futures contracts are trading higher than the deferred contracts. This gives traders the incentive to buy cheap crude to store in the hopes of selling it at a higher price in the future.

The recent sideways-to-lower price action by the March Crude Oil market may be reflecting traders buying and putting oil into storage. It tends to give the appearance on the charts of bottoming action. This is very similar to the chart pattern we have been experiencing lately. Although downside momentum may have slowed because of contango pricing, the trend and the fundamentals have not. 

From a technical perspective, crude oil is in a downtrend based on the classic definition of lower tops and lower bottoms. Recently, the daily chart showed signs of bottoming when it produced a higher top at $51.73. This particular chart pattern was negated, however, when crude oil crossed the recent bottom at $44.78. Nonetheless, short-term traders should keep an eye on $51.73 because the next time through it is likely to produce a strong short-covering rally.

The key number to watch on the weekly chart and the one that is likely to trigger the start of a meaningful short-covering rally is $49.13. This price is the highest close for the year. And the highest close after the first bottom was reached at $44.78. Sellers successfully defended this price the week-ended January 23, leading to the new weakness.

If you gather anything from this week's analysis, it is that if you are even considering the long side, you have to be willing to buy strength rather than weakness.

Natural Gas Outlook

Natural gas speculators betting the East Coast snow storm that hit the region earlier in the week would drive up demand were handed a surprise when the snow and cold weather failed to hit New York with the expected impact. The market broke sharply as these buyers were forced to liquidate their long positions amid predictions of warmer temperatures next week.

Buyers retreated quickly after the storm failed to live up to expectations and after the U.S. Energy Information Administration (EIA) reported that U.S. natural gas stocks decreased by 94 billion cubic feet for the week ending January 23. Although traders were looking for a drawdown of 113 billion cubic feet, which should've been bullish, this news was based on stale data and traders were looking into the future at next week's weather forecasts.

Like the crude oil market, relatively high natural gas stockpiles continue to curtail any attempts to sustain a bullish uptrend. This winter season is set to end with stockpiles close to 15% above their levels of a year ago and about 3% below the five-year average. With the winter season slowly coming to an end, and February about to start with warmer temperatures, it doesn't look like speculators will have any incentive to play the long side for any prolonged period of time.

If you are going to attempt to play the long side on weather shifts then you must be willing to play for short-duration moves since there is almost no time left in this year's winter season to begin a lingering cold snap long enough to put a dent into the large stockpiles.

Because of the size of the stockpiles and the steady production flow, almost all of the recent rallies have been driven by short-covering rather than fresh buying. Based on current trading data, it is going to take a massive shift in the fundamentals to scare the short-selling funds out of the market even if natural gas is nearing historically low figures.

The best indicator to use to trade natural gas at this time is not the weather, but hedge and commodity fund activity. These traders are controlling all of the price action not Mother Nature.