The technical picture for January Crude Highly has drastically improved since we wrote last week when the market was pressing $91.77. At that time, downside momentum and selling pressure were so strong that it seemed inevitable that the market would eventually reach the June 3 to June 24 price area at $90.35 to $90.40 respectively. With the Commodity Futures Trading Commission reporting a huge fund short position, it seemed the market was in strong enough hands to at least reach the psychological $90.00 price level before normal profit-taking and bottom-picking activity would chip away and test the resolve of the short-sellers.
This was not the case, however, as short-covering began a little earlier than anticipated when speculators dried up just a few days after the deal was reached to stem Iran’s nuclear program. The move was subtle at first which may have caught many of the weaker short-selling speculators by surprise. The idea to begin a short-covering rally during Thanksgiving holiday week now appears to be genius as the price action near the low at that time wouldn’t have been noticed because of the skewed volume levels in the market. Once the low was in at $91.77, it took just the matter of a little rumor about a drop in supply to begin the impressive short squeeze rally.
At the start of the week with crude oil speculators comfortably nestled in their short positions, many discounted the initial technical bounce as a set up for another round of fresh shorting pressure after a well-deserved short-term correction from the sell-off the week before. After all, the funds were short, Iran had just signed a nuclear reduction deal with six major nations, and crude oil supply was sitting a level not seen at this time of the year. With all these bearish indicators in place, it seemed like just a matter of time when the pronounced downtrend would take crude oil down to its identified objectives.
One problem that arose was the funds’ need to spread their resources around a little because of the possibility of an upcoming shift in Fed policy. With resources possibly needed in equities, Treasurys, Forex, and other commodity markets also sensitive to the Fed’s actions, fund managers quit selling crude oil, triggering the short-squeeze that sent speculators scrambling for the exit.
Confidence about the U.S. strengthening economy also fueled gains this week. Investors began to talk about the possibility of increased demand especially after a steep drop in supply for the week-ended November 29 was reported in the Energy Information Administration weekly report on Wednesday, December 4.
With the market starting its longest bullish trend on the daily chart in more than three months, energy investors started to react more positively to the strong economic developments, setting the tone for possibly another surge higher after the U.S. reports its latest Non-Farm Payrolls data on Friday, December 5. This is when trading conditions could get tricky, however, because a strong report may not necessarily mean higher prices if it also means a sharply higher dollar.
If the jobs data is strong then it may encourage the Fed to begin reducing monetary stimulus as soon as the end of this month. This could trigger a surge in the dollar which could hurt foreign demand for the dollar-denominated crude oil market. So before getting married to the long side of the crude oil market, keep in mind that the rally taking place is being driven by short-covering, not fresh buying. This may mean it will come to an abrupt end when the short-selling funds, propelled by the huge amount of supply. decide to refresh their short crude oil positions. In other words, it you missed this initial rally then chasing it at current levels may be dangerous. Looking for a pull-back to lower levels may be the best idea.
Technically, the January crude oil rally began to gain traction shortly after the market crossed back over to the strong side of an uptrending angle at $94.08 this week and the Fibonacci level at $94.12. This area becomes important support the week ending December 13.
In addition, an acceleration to the upside was triggered when the market broke through a long-term downtrending angle at $93.94 the week-ending December 6. This angle, moving down $1.00 per week from the $107.94 top is at $92.94 the week-ending December 13.
As long as the market can sustain gains over the 50% level at $96.76, then look for further upside action. The weekly chart indicates another 50% level at $99.86 is the next upside target. This is followed by a major downtrending angle at $100.44.
The chart pattern and the upside momentum suggest that investors should look for the short-covering rally to continue until the market reaches $99.86 to $100.44. Since the main trend is still down and inventory relatively high, look for aggressive short-sellers to re-emerge following a test of this zone.
Keep in mind that the current rally is being fueled by shorts paying anything to cover their positions. Although the improving U.S. economy may be contributing to the short-covering, unless there is a drastic, consistent drawdown in supply, the downtrend is likely to resume once the market retraces to a resistance area.