Just like a month ago we begin this Oil Investment Update with the words that we used to summarize the situation in the previous update (on Aug 6, 2015). We summarized the situation in the following way:
(...) crude oil accelerated declines, which resulted in a breakdown not only below the psychologically important barrier of $50 (...) but also in a drop under the Apr low and the support zone created by the 76.4% and 78.6% Fibonacci retracements. On top of that, yesterday’s decline (which materialized on sizable volume) verified the breakdown under these levels, which is an additional bearish signal. At this point, it is also worth noting that the last upward move was much smaller than the previous upswings (all marked with blue on the daily chart of crude oil), which clearly means that the down trend remains in place, suggesting lower values of the commodity.
Looking at the charts of crude oil from today’s point of view we clearly see that all the above-mentioned technical factors in combination with sharp declines on China's stock market, caused the price of black gold to decline very significantly. Not everything that took place on the crude oil market was bearish, though. The price reversed and rallied in a very sharp fashion just several days ago, so the million-dollar question is if THE BOTTOM is indeed in, or can one disregard the sharpness of the move and focus on the $50 level not being broken. In other words, the key question is if we can expect lower prices in the following weeks or should we prepare for a major rally. Let’s jump right into charts (chart courtesy of http://stockcharts.com) to find the answer.
Crude Oil
Looking at the weekly chart we see that although crude oil bounced off the blue support zone (based on the Jan lows) and the previously-broken black support line (based on Jan and Mar weekly closing prices), the commodity remains under the 38.2% Fibonacci retracement, which suggests that as long as there is no breakout above this resistance level further rally is questionable.
Will we see further improvement in the coming days? Let’s take a closer look at the daily chart and find out.
Looking at the daily chart, we see that the support zone created by the Jan lows (marked with red) in combination with the previously-broken red declining support line (the upper border of the red declining trend channel) triggered a rebound, which took light crude above $46. Taking into account the size of volume that accompanied yesterday’s increase, it seems to us that crude oil will likely move higher once again and will re-test the 50-day moving average in the coming day(s).
But will we see the commodity above $50 in the coming days? Let’s examine the long-term chart and find out.
From this perspective we see that crude oil moved sharply higher and invalidated small breakdown under the green support line (based on the Jan and Mar lows), which suggests further improvement. Nevertheless, when we take a closer look at the above chart, we can notice a potential head and shoulders formation. Therefore, as long as the commodity remains under the green dashed line, the probability of reversal is quite high. At this point, it is worth noting that even if light crude increases to around $54.24-$55.11, the above bearish formation still would be in play and will be able to encourage oil bears to act in the coming week(s).
Summing up, crude oil bounced off the red support zone (marked on the daily chart) on sizable volume, which suggests that we’ll likely see another test of the 50-day moving average in the coming day(s). Nevertheless, the proximity to the 50% Fibonacci retracement (based on the entire May-Aug declines and marked on the weekly chart) and a potential head and shoulders formation in combination with the daily indicators suggest that reversal and lower values of the commodity are just around the corner.
Having discussed the situation in crude oil, let’s examine the NYSE Arca Oil Index (XOI) to find out what the current outlook for oil stocks is.
Oil Stocks
Looking at the daily chart we see that oil stocks rebounded sharply after sizable declines and erased almost 62% of them. However, the 61.8% Fibonacci retracement encouraged oil bears to act, which resulted in a pullback. With this downward move, the XOI slipped to the green gap (it serves as the nearest support), which suggests that we’ll likely see a rebound from here in the coming days. Additionally, at this point, we would like to draw your attention to the island reversal pattern, which suggests that the final bottom may be already in.
Are there any other technical factors that could confirm the above? Let’s check the weekly chart and find out.
From this perspective, we see that oil stocks extended losses and approached the psychologically important barrier of 1,000 in the previous week (an intraweek low of 1,015). As you see, the proximity to this level encouraged oil bulls to act and resulted in a sharp rebound that took the XOI to slightly below the previously-broken resistance line based on the Nov 2012 low. What’s next? Taking into account the short-term picture and the current position of the weekly indicators, it seems that oil bulls will try to push the index higher in the coming week(s).
However, to have a more complete picture of oil stocks, let’s focus on the long-term chart. What can we infer from it?
The first thing that catches the eye on the monthly chart is a drop to the long-term black support line based on the Oct 2008 and Mar 2009 lows. As you see, this solid support triggered a sharp rebound, which suggests that even if oil stocks move lower once again, this key support line will likely stop oil bears once again. On top of that, the Apr-Aug decline is almost the same as declines between June and December 2014, which increases the probability of reversal and higher values of the XOI in the coming weeks (or even months).
Summing up, oil stocks extended losses and declined to very important support zone created by the long-term black support line (based on the Oct 2008 and Mar 2009 lows) and the barrier of 1,000. This area triggered a sharp rebound, which created the island reversal pattern on the daily chart and erased almost 62% of the Aug declines. All the above suggests that higher values of oil stocks are just around the corner (even if oil stocks moves lower once again, the above-mentioned key support zone will be strong enough to stop oil bears and further deterioration).
Ratio Analysis
Once we know the current situation in crude oil and oil stocks, let’s focus on the relationship between them. What can we infer from the chart below?
Quoting our previous Oil Investment Update:
(…) sell signals are still in play, we think that the ratio will test the previously-broken declining line in the coming week(s). If this is the case, such price action will translate to another downswing in light crude.
Looking at the above chart, we see that the situation developed in line with the above scenario and the ratio slipped below the green support line. Despite this drop, the ratio reversed and invalidated earlier breakdown. This positive signal triggered further rally and a comeback to the key resistance area created by the red gap, the 38.2% Fibonacci retracement (based on the Oct-Mar declines), the red dashed declining resistance line (based on the Oct and Jun highs) and the 50-week moving average. As you see on the chart, in previous months, the 50-week moving average was strong enough to stop further improvement and trigger a sizable downward move, which suggests that we could see similar price action in near future – especially when we take into account all the above-mentioned bearish factors. What does it mean for crude oil? Based on price action that we have seen in the past, we think that lower values of the ratio are just around the corner. If this is the case, and the ratio declines from here, such price action will likely translate to a pullback in light crude – similarly to what we saw in June.
Having said that, let’s find out whether we can infer something more about future crude oil’s moves from the oil-to-stocks ratio or not.
From today’s point of view we see that the ratio rebounded sharply and approached the 61.8% Fibonacci retracement (based on the May – Aug decline), which suggests that the space for further gains may be limited – especially when we factor in the proximity to the red gap between the Jun 29 low and the Jul 6 high. Therefore, if the ratio reverses and declines, we’ll likely see similar price action in the commodity.
Once we know the current situation in the stocks-to-oil ratio, let’s analyze the oil-to-gold ratio.
Quoting our last Oil Investment Update:
(…) the previous weeks brought declines (…), which took the ratio under the support zone created by the Feb highs. This bearish sign triggered further drops, which resulted in a breakdown under the green support line based on the previous lows. This is an additional negative signal, which suggests further declines – especially if we see a drop under the 61.8% Fibonacci retracement (which is highly likely as sell signals remain in place).
Looking at the weekly chart we see that the ratio moved sharply lower (as we had expected) and slipped below the Jan low. Despite this drop, the ratio reversed and invalidated earlier breakdown very quickly, which resulted in a rally to the previously-broken green support line based on the Jan and Mar lows the red resistance zone (based on Feb highs) and the 50% Fibonacci retracement (based on the May-Aug declines). In our opinion, this solid resistance area is strong enough to stop further improvement and trigger a bigger pullback in the coming weeks. If this is the case, and the ratio moves lower, crude oil will likely also reverse – similarly to what we saw in the past.
Non-USD Crude Oil Price
Know the situation for the above ratios, let’s move on to the non-USD (WTIC:UDN ratio) chart of crude oil. As a reminder, UDN is the symbol for the PowerShares DB US Dollar Index Bearish Fund, which moves in the exact opposite direction to the USD Index. Since the USD Index is a weighted average of the dollar's exchange rates with world's most important currencies, the WTIC:UDN ratio displays the value of crude oil priced in "other currencies".
From this perspective, we see that the ratio rallied sharply and approached the 50% Fibonacci retracement earlier this week. Despite this move, the ratio gave up some gains and slipped under the previously-broken green support/resistance line (based on the Jan and Mar lows). Taking this fact into account, it seems to us that as long as there is no weekly close above this important line another attempt to move lower is likely (even if oil bulls try to re-test it in the coming days). If we see such price action, it will translate to lower values of light crude in the coming week(s).
Scenarios
Just like a month ago, today’s Oil Investment Update includes scenarios of what could happen in the coming weeks. Naturally, we will continue to monitor the market in the coming days and if anything invalidates our long-term outlook we will send you an additional message.
- Bullish scenario
If crude oil moves higher and breaks above the 50-day moving average, we’ll likely see an increase to around $53, where the 200-day moving average, the 61.8% Fibonacci retracement (based on the May-Aug declines) and the long-term red declining resistance line (based on the Sep 29 and Jun 15 weekly opening prices - marked on the weekly chart) are. If this price level is broken, the next target for oil bulls would be around $55.34-$56.50, where the gap between the Jun 29 low and the Jul 6 high is (this area is currently also reinforced by the long-term red dashed declining resistance line based on the Sep 29 and Jun 15 intraweek highs). - Bearish scenario
If the commodity declines below the red support zone based on the Jan lows and the previously-broken red declining support line (the upper border of the red declining trend channel), declines will accelerate and we’ll see a test of $40. If it is broken, the next target for oil bears would be the Aug low of $37.75 or even the support zone based on the Dec 2008 and Jan 2009 lows (around $35.13-$35.52).
Summary
In the last weeks of August crude oil accelerated declines, which resulted in a breakdown not only below the Mar low and the lower border of the declining trend channel, but also in a drop under the psychologically important barrier of $40. In this way, the commodity dropped to its lowest level since Feb 2009, hitting a multi-year low of $37.75. Despite this deterioration, light crude reversed and rebounded sharply, invalidating earlier breakdowns and climbing to the 50-day moving average (slightly below the barrier of $50). At this point, you are probably wondering whether this is just a correction of the earlier declines or the beginning of a new upward movement. Taking into account a potential head and shoulders formation (marked on the long-term chart) and the current position of the above ratios, which reached important resistance levels (in all cases their reversals will translate to lower values of crude oil), we believe that lower values of crude oil are just around the corner (even if light crude re-tests the 50-day moving average and the barrier of $50).
Very short-term outlook: mixed with bullish bias
Short-term outlook: bearish
MT outlook: bearish
LT outlook: mixed with bearish bias
Trading position (our opinion): No speculative positions are justified from the risk/reward perspective.
This completes this month’s Oil Investment Update. Our next Oil Investment Update is scheduled for Thursday, Oct 1, 2015. Oil Trading Alerts subscribers will additionally receive similar but shorter alerts on a daily basis (or more than once a day when the situation requires it). You – Oil Investment Updates subscribers – will receive short Investment Alert messages should the outlook for the medium or long term change before the next Update is posted.
Thank you.
Nadia Simmons
Forex & Oil Trading Strategist
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