WTI: The Same Price But A Different Play

The last time I wrote in these pages was two weeks ago, as I spent last weekend at a trader's conference, and at that time, with WTI trading at just over $43, I said that I was unsure of where we went from there and would be sitting on my hands. If you don't look at a chart and just know that we are now, two weeks later, trading at just above $43 that makes me look like a genius who can call lack of movement just as much as movement. The reality, however, looks like this…

(Click to enlarge)

Figure 1: Two week 30 minute chart for QM

Yes, while my indecision raged, WTI climbed a full ten percent and then dropped back again, all in a two week period. In fact, while I didn't see the move up coming, I and my Energy Trading Team members did get short using the leveraged ETF DWTI on the way back down again, so it wasn't a wasted couple of weeks.

Now that we are back at the same levels as two weeks ago though, it doesn't mean that I am in the same place. This time there are less contradictory messages, and a few good reasons to believe that even from here we could see a fairly big move. As usual when a trade looks worth taking, both technical and fundamental analysis now point the same way.

From a technical perspective, while the shoulders are a little stubby and slightly deformed, the chart above still looks to me like a big head and shoulders pattern, or at least something that suggests the same thing. After a period of indecision, the market tried to force things to the top side and failed. After climbing the chart shows a quite rapid fall back to the starting point. A bounce off of that point and subsequent decline have formed a kind of hunched shoulder, and if we take it to be that then a classic, conventional read of the chart says that the next move should be downwards. The logic is obvious; having tried the topside and failed traders will now probe the downside for weakness.

If all of that sounds like mumbo-jumbo to you and you scoff at the notion that past price action has anything to do with what is to come, then consider this…there is a clear fundamental case to be made that oil is overvalued. When I wrote that piece two weeks ago I said that at that time too I thought the fundamentals pointed to lower oil over time. What worried me then, though, was that there could be a significant move in the other direction before that dynamic took hold, based on market positioning and sentiment.

That is what we got, but those conditions are no longer present. At that time traders were in the process of convincing themselves that there was no chance that the Fed would raise rates this month, and even a hike in December was unlikely. That put pressure on the Dollar and the prospect of more monetary stimulus, and therefore more growth, gave even oil a bullish tone. About a week ago, though, it began to dawn on the market that there was some chance of an early move by the Fed. It may not be a big chance, but it was certainly more than the market was pricing in at that time. Bond yields and the dollar started to rise, and stocks started to wobble. Oil, as a consequence, fell.

Now we have that Fed related adjustment and counter adjustment out of the way, we are left focusing on the supply and demand outlook, and that is pretty dismal. We actually saw a drawdown of inventories that beat expectations this week, which has been a rare thing lately, but that doesn't mean that we should get carried away. Looking at the late summer season as a whole, when vacation driving and manufacturing and shipping demand as the economy gears up for Q4 usually result in big draws, it is disappointing at best. There is still a huge global oversupply that is adding to an existing glut of crude. Despite some valiant efforts to talk up the price of oil recently there is no sign that OPEC will do anything in the near future to actually cut supply.

If all of this weighs enough to push WTI through the $43 level then there is nothing from a technical standpoint to stop it until we hit at least $40. Right now, even though we are at almost exactly where we were when I advised no action two weeks ago, what has happened since has changed the picture. Short oil now looks like a decent position.