Investors Should Sell Weakness For The Time Being

June Crude Oil futures rallied earlier this week, taking out the psychological $60.00 level in the process. The rally was triggered by a price hike by Saudi Arabia, a protest at a key Libyan port and thoughts that U.S. inventories had finally leveled off.

The news from Saudi Arabia was light this week, but one event did help underpin the market. The Saudis announced that it had raised its official selling prices for its Arab Light grade crude to the United States and Northwest Europe. The move was based on stronger demand in those two areas.

Another event that helped support higher prices was the stoppage of crude flows to the eastern Libyan oil port of Zueitina by protestors. This move hampered exports. This was a key event because Zueitina is one of the few Libyan ports still exporting oil. Unlike the events in Yemen that are still being watched while having no effect on supply, a shutdown of Zueitina will have an effect on supply. At this time, Libyan oil output is under 500,000 barrels per day which is well below what it pumped just five years ago. Taking out Zueitina while not a major event, does limit output further.

This week's U.S. Energy Administration inventory report for the week-ending May 1 showed that crude oil inventories fell 3.9 million barrels. On paper, this was a bullish number because traders had been looking for a slight rise of 1.3 million barrels. This news triggered a spike in oil prices that was met with heavily resistance, fueling a profit-taking break.

The problem wasn't with the crude oil figure although the leveling off process may be taking more time than speculators can handle, it was with the report that showed gasoline inventories rose. The EIA inventory report showed gasoline supplies rose 401,000 barrels last week. Refineries ran at a better-than-expected 93% of production capacity, up from 91.3% a week earlier.

Although gasoline prices are at their highest level of the year, a break from current levels at this time wouldn't come as a surprise since gas prices traditionally hit their peak during the spring, when refineries shut down for seasonal maintenance and switch over to summer blend gasoline. This year appears to be no different based on this week's price action.

Looking at the weakness in gasoline after the EIA report on May 6 and its subsequent influence on crude oil prices, one has to assume that a sell-off in gas will likely put similar pressure on the June crude oil contract.

Besides the potential drop in gasoline prices, the possibility that U.S. oil companies may be ready to bring a few more wells online now that the recent price rise may have made them profitable again, could also help to drive prices lower over the near-term.

This week's rally by June Unleaded Gasoline came to a screeching halt at $2.0950. This was well below the projected target at $2.2239. The market may eventually reach this target, but not before making a near-term correction.

This last rally from $1.6799 to 2.0950 nearly balanced the previous rally from $1.5370 to $1.9617 in terms of price and time. The first rally was .4151 in six weeks. The current rally is .4247 in seven weeks. This is a sign of controlled buying rather than speculative buying which tends to produce spike moves.

This week's price action suggests the market may be in a position to post a weekly closing price reversal top. This potentially bearish chart pattern often leads to a 2 to 3 week break equal to 50% to 61.8% of the last rally, making $1.8875 to $1.8385 the primary downside target. 

The price action by June Crude Oil mirrored the movement by the June Unleaded Gasoline futures contract except the second rally was greater in terms of price and time.

This week was the seventh week up from the $45.93 bottom. Typically, markets top out with dramatic closing price reversals during the 7 to 10 week period so the start of a near-term correction will not come as a surprise.

Although the market showed signs of bullishness on its way to $62.58, a close under $59.15 will form a closing price reversal top, setting up the market for a 2 to 3 week correction into $54.26 to $52.29.

Conclusion

Two-to-three week corrections are quite normal during any developing bull market so longer-term investors should not panic if unleaded gasoline or crude oil break over the next two weeks into their key retracement zones.

Investors can either buy strength or sell weakness. Since there are still concerns about supply, investors may be reluctant to buy strength at this time, preferring instead to buy a pull-back into a value zone. This is why we are looking for unleaded gasoline to correct into $1.8875 to $1.8385 and crude oil into $54.26 to $52.20 over the next 2 to 3 weeks.