October Crude Oil futures failed to follow-through to the upside after last week’s surge took out the recent top at $107.85. The subsequent sell-off suggests overbought conditions and a possible shift in the fundamentals.
Earlier in the month, a falling U.S. Dollar and escalating unrest in Egypt encouraged speculators to drive up crude oil. Since crude oil is dollar-denominated, a drop in the Greenback made crude oil less expensive for foreign investors. This was expected to drive up demand. As the situation in Egypt unfolded, speculators became concerned about the possibility of supply disruptions in the Middle East.
With both supply and demand potentially being affected simultaneously, crude oil speculators experienced the “perfect trading storm” and took advantage of the situation by driving prices from $101.82 to $107.93 in a short-period of time.
As conditions improved somewhat in Egypt, speculators began to pare their long positions, instead choosing to focus on the upcoming Fed minutes which were due to be reported on August 21. This report was expected to directly affect the direction of the U.S. Dollar since it would reveal how Federal Reserve members felt about the possibility of the central bank reducing its $85 billion in monthly stimulus.
Although the Fed minutes didn’t reveal any surprises, it didn’t dispel the thought that the Fed would begin tapering as early as September. This action by the central bank would lead to a rise in U.S. interest rates and greater demand for the dollar as an investment. A stronger dollar typically means lower foreign demand for crude oil. Speculators anticipating this action by the Fed next month began liquidating their long positions, leading to this week’s sell-off.
The unknown factor at this time is Egypt. Because political unrest and violence could erupt at any time in this nation, there should be a bid in the market, preventing a complete washout to the downside. What could put some pressure on crude oil next week would be a sharp rise in the dollar. The Greenback is likely to rise if the U.S. economy continues to improve. No one will be certain about what the Fed will do at its September 17 – 18 meeting, but a better-than-expected U.S. Non-Farm Payrolls report on September 6 will give investors an important clue.
Because of the balanced fundamentals and the overbought technical indicators, it looks as if crude oil is going to remain range bound with a slight bias to the downside.
Technically, a trade through $101.82 will turn the main trend down on the weekly chart, but an acceleration to the downside is likely to be avoided because of the retracement zone support at $100.10 to $98.24. On the upside, a sustained move through $108.00 is likely to trigger a fast rally to $110.00.