February crude oil consolidated on the weekly chart last week, suggesting the market may be poised for another short-covering rally. Based on the short-term range of $100.75 to $91.24, traders are anticipating a rally into the retracement zone at $96.00 to $97.12. Since the main trend is down, short-sellers are likely to show up following a test of this zone, setting up the market for another drive toward the $90.00 area.
Despite a clearly defined retracement zone and upside target, the expected rally into this zone is likely to be labored because of various resistance angles and confusing fundamentals. The first resistance is an angle from the $100.75 top at $94.75 the week-ending January 17 and $92.75 next week. This is followed by another major downtrending angle at $96.22 this week and $95.72 the week-ending January 24. Upside momentum is going to have to be strong enough to drive through these levels. Since short-covering has been the main driver of upside action recently, the rally is expected to be weak. This will leave the market in control of the bears.
Last week, the Energy Information Agency reported a seventh consecutive drop in crude supplies, but the news failed to attract any significant buying interest. A few of the weaker shorts covered, but too many concerns kept bullish investors on the sidelines. In addition, despite oversold conditions on the daily chart, there just doesn’t seem to be any solid interest on the long side at this time.
Helping to keep out foreign interest is the rising U.S. Dollar. Since crude oil is dollar-denominated, a stronger dollar tends to make crude oil more expensive for foreign buyers, leading to a drop in demand. Earlier in the week, crude oil received a little boost after a U.S. manufacturing report triggered some speculative demand, but this news also helped underpin the dollar, limiting the upside action.
According to the EIA, crude oil supplies dropped by 7.7 million barrels for the week ended January 10. Analysts missed this number by a long shot, calling for a decline of only 1.6 million barrels. The American Petroleum Institute reported a drop of 4.1 million barrels.
During the course of the current seven week drawdown, crude oil supply has dropped 41.2 million barrels. Under normal trading conditions, the size of this drawdown would’ve triggered a larger rally than we are experiencing at this time. It could be that investors are discounting future demand because of the increase in gasoline supply. According to the latest statistics, gasoline stockpiles climbed 6.2 million barrels the week-ended January 10.
Besides the stronger dollar and concerns about domestic demand, traders are also worried that increased supply from Libya and Iran will keep a lid on any strong price moves. The inability of the market to react positively to the news that OPEC will lower output further and is pumping less than this year’s global need for its crude is also a sign that sellers are still in control. This may be because U.S. domestic crude oil production is enough to meet future demand needs.
In summary, despite the series of weekly drawdowns, crude oil has not been able to muster anything more than short-lived, short-covering rallies. This is likely to continue until the market establishes a support base that is successfully defended by strong buyers. The main trend will not change to up on the weekly chart until $100.75 is taken out. This means the market may have to consolidate for several weeks before a new, lower swing top can be established.
If the market does rally, look for the retracement zone at $96.00 to $97.12 to stop the move and attract a fresh round of short-selling. Prices may have to correct back to $85.00 before value buyers step in to support it.