Thursday, April 21, 2011

Thursday Oil Market Analysis

Last week, I wrote the following about the oil market:

Going forward, I would expect prices to continue moving lower. However, I would view this as a temporary development. The lower MACD print, strong downward candles and increased volume on the latest sell-off indicate profit taking is in order.

While there are signs of a slowdown, no one (except those who can't help themselves) is calling for a recession. Instead, analysts are noting that high oil prices will lead to lower growth.

In addition we are moving into the summer driving season, which historically leads to higher demand and therefore higher prices.

My thought process was essentially prices were in the middle of a correction, largely caused by the phrase, "the only cure for higher oil prices is high oil prices;" high oil prices strangle economic growth, lowering demand for oil, hence lowering oil prices. However, there is clear support in the market. Consider the 6 month chart:

There are two important trend lines on this chart. The first starts at a low in late November and the second starts at a low in late February. While the shorter one is a bit steeper, it is not parabolic, so it could conceivably hold for some time. The 50 day EMA is moving higher, indicating a rising, longer-term trend, but the shorter EMAs are less steep, indicating a pause. However, the EMAs are still bullishly aligned.

The declining MACD is concerning for the bulls, as the indicator has printed lower tops for higher price action, which is usually a sign of a stalling market.

In addition, consider this shorter chart:

Over the last few weeks, with the exception of today, the price action has been weak. There were two strong down bars, three weaker moves higher, another strong downward bar and then a weak up bar. Today's action is the only strong bar over the last 8 trading sessions.

The overall feeling I can't shake is that with gas at $3.84/gallon on average, traders are incredibly sensitive to the effect of higher oil prices on the expansion. This is probably what led Goldman to issue its sell recommendation on commodities last week. In short, I keep thinking we already have a top built into the market caused by economic fundamentals. On that order, consider this chart from the St. Louis FRED:

The chart compares Brent Crude and regular gas prices on a scale of 100. The last time gas prices were at or near this level was the beginning of the last recession. While we probably still have some upside room for gas prices before we hit recession inducting levels, we're a lot closer than we want to be at this point. In short, I have to wonder how much upside room oil prices have before we hit a slowdown, and hence have traders selling long positions.