Why Oil Bears Should be Alert to the Possibility of a Reversal Next Week

Regular readers will be aware that I have, for the last few weeks, been generally bearish on the price of oil, and for two main reasons. The strength of the dollar had until recently gone unnoticed in much of the financial media, but it has been a sharp climb and, while the inverse relationship between the dollar and oil is not a perfect, tick for tick thing, a high dollar does put a cap on oil's upside potential and keeps pressure to the downside. In addition, the main reason for oil's climb a month or so ago, the potential agreement by OPEC to limit production, is not a reality yet and still faces significant hurdles. That bearish view has worked out well, but there is a good chance that it will change in the next few trading days, as both things that have driven oil down look like changing.

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Figure 1: Dollar Index 6 Month Chart. Source: Marketwatch.com

Firstly, there are signs that the dollar's rise is overdone and that the direction is about to change. In terms of the dollar index, significant resistance has been met just above 99 and, as the chart above shows, upward momentum has ceased over the last few days. That is hardly surprising. The move in the dollar has been driven by the expectation of a Fed hike in interest rates, but that now looks fully priced in. The market can be expected to start to adjust for the, admittedly slight, possibility that the U.S. central bank will once again back away from the tough decision to risk a market selloff, and will further delay that hike.

Secondly, and probably more importantly, the OPEC meeting at which talks of an agreement will take place is at the end of November, and as it approaches a change of tone in the chatter surrounding that meeting looks likely. I have written in the past about the tendency of the OPEC nations to talk their book and that will probably be a factor over the next few weeks. Even if, and maybe especially if, the members see the obstacles to an actual agreement as insurmountable, it will be in all of their interests to keep those opinions to themselves and talk up the chances of a production freeze, or even a cut.

Since the potential deal was announced, OPEC members, and the Saudis in particular, as demonstrated by their last production numbers, have ramped up production to take advantage of the spike in prices. If they see a deal as difficult to achieve or enforce there is every reason to keep a positive spin on the upcoming meeting to continue to take advantage of that. Doubts and dissent such as those recently aired by Iran will be muted, and the market, faced with a seeming determination to reach a deal, will likely react positively.

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Figure 2: E-Mini Oil Futures 1 Year Chart

Those two things combined make it likely that oil prices will turn tail at some point soon and climb back towards the $52 top, but I am not prepared to change direction quite yet. There is still strong resistance over $51 in WTI as those levels seem to attract a lot of hedging from U.S. producers, and the knowledge of that alone should keep oil down for at least a few more days. If, as I expect, the dollar does start to correct next week, however, and if we start to hear positive murmurings from OPEC members, that move down will reverse at some point soon.

The message for traders and investors here is to stay alert, and not to get too comfortable with short positions. No move lasts forever, and over the next few days taking profits at the very least, if not actually reversing to long positions looks like the best strategy for now.