U.S. West Texas Intermediate crude oil futures opened the new month under pressure, continuing the assault on prices that began on the third day of trading in October when the market was touching a multi-month high. At the start of the month the talk was bullish with predictions of another $10 to $20 to the upside. By the end of the month, the forces driving the market lower had wiped out 2-1/2 months of gains.
Traders blamed the weakness on a number of factors including the strong U.S. Dollar, stock market volatility and weakness, the escalating trade dispute between the United States and China, and rising global supply. The narrative that the market was "fragile" and that there were spare capacity issues seemed to disappear overnight. Instead, the focus shifted to the possibility that the market was oversupplied.
The rising U.S. Dollar was an issue in October because it hurt foreign demand for dollar-denominated commodities. The dollar was supported by rising interest rates which made the dollar a more attractive asset than other currencies. Essentially, it was the divergence in the monetary policies of the hawkish U.S. Federal Reserve and the other dovish major central banks that underpinned the greenback,
Safehaven buying also drove the U.S. Dollar to a 16-month high as stock market weakness encouraged global investors to seek shelter in the currency of the best performing country.
The steep sell-off in the U.S. equity markets and heightened volatility also weighed on crude oil prices. According to energy expert John Kilduff, an unusual phenomenon affecting crude oil and stock market weakness took place in October. Kilduff said that oil and the stock market embarked on the closest trading relationship since early 2016 and during the financial crisis sell-off.
"A lot of folks like to trade crude oil and other commodities to get away from the correlations you have in the stock market," said Kilduff. He further added, "This has been the highest correlation that I've seen in quite some time."
The tight relationship between stocks and crude may have led hedge funds to dump positions due to margin calls, further accelerating the sell-off.
The issue over the escalating trade dispute between the United States and China came up again in October. This time it was being blamed for weakness in emerging market economies and currencies. Institutions like the International Energy Agency cut forecasts for oil demand this year and next because of growing threats to global economic growth, yet it also warned that dwindling spare oil supplies will keep prices high.
"Expensive energy is back" and "it poses a threat to economic growth," said the IEA, which advises most major economies. "For many developing countries, higher international prices coincide with currencies depreciating against the U.S. dollar, so the threat of economic damage is more acute." Related: U.S. And OPEC Flood Oil Market Ahead Of Midterms
Finally, as the bearish factors continued to pile up in October, the issue of oversupply was raised. According to the latest reports, Russia pumped 11.41 million bpd of crude in October, a 30-year high. The U.S. Energy Information Administration reported that U.S. production is now well over 11 million bpd. OPEC reported oil production in October jumped to 33.31 million bpd. Those three countries are now producing about a third of daily global demand.
Fresh Month, Fresh Outlook
The new month began with crude traders concerned about the prospects for oil supply when new U.S. sanctions are implemented against Iran on November 4. For several months a supply shortage was an issue, but it now looks as if oversupply will continue to hang over the markets.
There is another development brewing that could be a positive for crude oil prices. There are reports that the U.S. and China are taking about a resolution to their trade dispute.
On Friday, global equity markets surged on comments from U.S. President Trump indicating a trade deal with China may be in the works. Investors started to take notice of the deal on Thursday when Trump tweeted that he had a "long and very good conversation" with Chinese President Xi Jinping on trade.
The President then went on to say in his U.S. morning tweet that trade "discussions are moving along nicely".
There is also a report circulating that says President Trump is interested in reaching an agreement on trade with Chinese President Xi Jinping at the Group of 20 summit in Argentina later this month and has asked key U.S. officials to begin drafting potential terms.
A trade deal between the U.S. and China will take care of several factors that were being blamed for the steep sell-off in crude oil last month. This can only be bullish for crude oil prices. The only factor that it won't take care of is the excessive production from the U.S., Russia and Saudi Arabia, but this can be fixed over the near-term. The Saudis and Russians definitely know how to do that because they done it for about two years.
Even with the overproduction issue, the ending of the trade dispute should be bullish for crude oil prices.
Firstly, if the strong dollar is being blamed for making crude oil too expensive for foreign buyers then a weaker dollar should lead to increased demand. If a trade deal is made, the dollar should weaken because investors who bought the dollar to hedge against an economic slowdown will be encouraged to trim those positions.
Secondly, we're already seeing what a report of a possible trade deal is doing to the stock market. If stock market weakness and volatility helped drive oil prices lower, then a stock market rally and an easing of volatility should be supportive for oil prices.
Thirdly, the end of the trade dispute should be good for the global economy. If economies begin to improve then demand should increase and this should help trim the growing supply.
We haven't seen yet in the crude oil market, but I believe that the end of the trade deal will be bullish for prices. The U.S. and China just have to get it done.
Technical Analysis
(Click to enlarge)
One chart that WTI crude oil traders are watching is the 200-Day Moving Average Chart. This week, the nearby WTI crude oil market crossed under the trend line for the first time since October 20, 2017. This put it in a bearish position. Currently, the average comes in at $66.12.
This is the indicator that many hedge funds and institutions use to gauge the strength or weakness of a market. Despite holding above this moving average for almost 52-weeks, it doesn't have to regain it quickly. The last prolonged period under this moving average lasted nearly 8 months.
Also expect to see several stops and starts as the market tries to regain this average. This is because it is also used as resistance by short-sellers.
(Click to enlarge)
Besides the 200-Day Moving Average Chart, traders will also be watching the longer-term weekly chart for direction. After a prolonged move down in terms of price and time, many professional shift to the weekly chart because it is a good indicator of value. Related: Soaring U.S. Oil Production Forces Prices Down
In order to stop the selling, the crude oil market is going to have to reach a value zone. Given the $45.51 to $76.72 range, the nearest value area is its 50% to 61.8% zone at $61.12 to $57.43. A test of this area is likely to bring in fresh buyers.
On the upside, the key price to watch this week is a downtrending angle at $66.72. This angle has guided the market lower for four weeks in addition to providing resistance.
From a technical standpoint, crude bulls are going to have to wait for prices to hit a value zone or they are going to be forced to buy strength over the 200-day moving average of the downtrending angle.
Conclusion
If the U.S. and China reach a trade agreement then look for a strong short-covering rally. In this case, buyers will be willing to pay up for crude oil. The market will then turn bullish over the 200-day moving average at $66.12. Crude oil will strengthen further on the weekly chart over $66.72.
If there is no deal then the 200-day moving average will be resistance and prices will continue to move lower until buyers find value.
By Jim Hyerczyk for Oilprice.com
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