Regular readers will be aware that I am not one for overly complex technical analysis. Sometimes, however, all markets do trade based on technicals. When an obvious and well followed chart point is reached the ensuing price action often gives a clue that we would be foolish to ignore. That is the case now with oil prices.
Now that oil is recovering, it is tempting to think that it will be a straight line recovery back to at least the $80/Barrel level for WTI. Of course logic tells us that straight line moves rarely happen, and that at some point oil will turn tail and trade lower again. Not only is that likely, it is also necessary if the recovery is to be a solid, lasting one in the long term. It looks as if that point was reached this week and a correction of some sort back to the downside now looks extremely likely.
Fundamentally nothing much has changed to affect the oil price in the last few days. The dollar is still tracking lower which should give support, and on the other side of the coin questions still remain about global growth which is having the opposite effect. A continuation of the steady bounce back that we have witnessed would normally be expected in that situation, especially given that U.S. oil stocks continued their decline this week. Instead though, what we have seen is a sharp decline on Wednesday and Thursday that took WTI back below the psychologically important $60 level. The best explanation for that is a technical one.
The…
Regular readers will be aware that I am not one for overly complex technical analysis. Sometimes, however, all markets do trade based on technicals. When an obvious and well followed chart point is reached the ensuing price action often gives a clue that we would be foolish to ignore. That is the case now with oil prices.
Now that oil is recovering, it is tempting to think that it will be a straight line recovery back to at least the $80/Barrel level for WTI. Of course logic tells us that straight line moves rarely happen, and that at some point oil will turn tail and trade lower again. Not only is that likely, it is also necessary if the recovery is to be a solid, lasting one in the long term. It looks as if that point was reached this week and a correction of some sort back to the downside now looks extremely likely.
Fundamentally nothing much has changed to affect the oil price in the last few days. The dollar is still tracking lower which should give support, and on the other side of the coin questions still remain about global growth which is having the opposite effect. A continuation of the steady bounce back that we have witnessed would normally be expected in that situation, especially given that U.S. oil stocks continued their decline this week. Instead though, what we have seen is a sharp decline on Wednesday and Thursday that took WTI back below the psychologically important $60 level. The best explanation for that is a technical one.
The above chart is for the US Oil ETF (USO) which acts as an accessible proxy for oil prices in America. The declining white line above the main bar chart is the 200 day moving average (200MA). As you can see it is that, rather than the $60 round number which equates to around $20 for USO, that provided enough resistance to stop the upward move. The picture is similar, if not quite as clearly defined, if you look at the oil price on which USO is based. That sailed through $60, but changed direction after bouncing off of the 200MA at around $62.
It may seem that such a technical move will, by its very nature, be short term and so should not concern those who hold stocks of oil producers in the belief that oil, like everything else, will return to the mean eventually. To some extent that is true. I have said on several occasions that buying into the hard hit, but now leaner and meaner, land based exploration and production (E&P) companies is the best way to play the bounce and I still believe that to be the case. The problem is that those stocks are still extremely volatile and any move down in WTO could well see a return to panic selling. Even if that is temporary, it could be painful, so while I remained bullish as recently as last week it would be prudent to take some defensive actions now.
The sensible course of action would be to heed the signal that a bounce off of the MA sends and at least trim your positions in E&P stocks at this point. It never hurts to take a little profit and if oil does continue lower you will be able to pick those stocks back up significantly cheaper over the next few weeks. If the 200MA is tested again, and this time breaks to the topside you could reinstate the positions, having only missed out on a few percentage points of appreciation. That seems like a reasonable price to pay for insurance against this technical move proving to be significant.
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