When discussing this analysis we shall focus on WTI, the
markets trade together for all intents and purposes, just that Brent trades $20
higher, give or take $3, depending upon certain European and Middle East news,
and contract rollover repositioning (i.e., Brent contract rolls before WTI).
King of Day Trading
Brent has gained importance, and is used much more for benchmark
due to the fact that it better represents global prices, and most refiners sell
their end products based upon the Brent contact. However, WTI is still the
undisputed King of Day Trading, and has the dedicated Pit presence in New York
which runs from 8:00am to 1:30pm CST, and ultimately is still where all the
consistent, major price discovery takes place. Or to say it non-euphemistically,
the Pit is where all the action is! So WTI is still by volume the most widely
traded crude oil contract in the world on a consistent basis, and we will base
our technical analysis on the WTI CL contract.
Fundamental WTI
Expect a push-up with all other risk assets if we get some
semblance of a fiscal cliff deal or expect a push- down if we fall off the
cliff. Depending upon the makeup of the fiscal cliff deal, i.e., the Grand Design,
or just kicking the can down the road with a minimalist measure, there will be
some type of rally in crude oil.
Crude oil, unlike equities, will still have to account for
the fundamentals which have been bearish, and could temper any rally from
developing into a sustained trend. For example, even though crude oil is being
purged for tax purposes and refineries are running at a 90% run rate, it is
barely making a dent in crude oil supplies, and the end products are starting
to build inventories because the demand for end products just isn`t strong
enough right now.
Rising petroleum end product inventories means less need for
oil in the future. I expect products to build with slight draws in crude oil
through the end of the year. If we get builds in both crude oil stocks and end
product stocks, it will put downward pressure on oil, and we will test the $84
level to validate whether that level holds through the remainder of this year.
Technical WTI
Oil trades like an asset class similarly to equities or gold. If we have an event where major selling
occurs in all asset classes, this is the most likely scenario for buyers
stepping away from the $84 level, and letting WTI fall to the next level of
support at around the $80 level, with the next support at $78 a barrel. These
are the near-term levels of support that have always supported the contract,
and where buyers have stepped in after major push downs, usually liquidation
events are responsible for reaching the $78 level. Then buyers step in, the
shorts cover and price moves rather quickly to the $83 level.
The first quarter of every year is where fund managers make
their numbers, so new money usually flows into asset classes during the first
of the year. Under that scenario, WTI should move up and test the upper part of
the range, and whether it can push through the $90 level will depend on whether
inventories can come down, i.e., several weeks of drawdowns leading to months
where we take 10 to 12 million barrels off the existing inventory levels in the
370 million area currently. We need to see at least 30 million barrels of
drawdowns to move price back to the $95 a barrel level. Without this any
rallies in WTI will be faded or sold into curtailing any sustained momentum
from forming.
So oil for the next three months will be more of a Trader`s
market and less of a trending market where traders have to take pieces of
prices where they can, and avoid buying or selling the top and bottom of the
market unless extreme circumstances present themselves. The trader can buy
small technical price breakouts, but always be wary of being too committed to
these breakouts, as we have seen by the last two months price quickly reverts
back to the bulk of the trading range.
The successful CL trader will be nimble, watch their
technical levels, and get in and out for the most part, with occasional mini trends
to take advantage of from time to time. With abundant supply levels, volatility
is definitely on the decline. Most of the volatility will probably stem from asset
rebalancing, market dislocations in one asset class affecting other asset classes,
and I expect more volatility to the downside than upside.
Real Down Side Pain
The stronger case for real pain, i.e., participants stepping
away from the market or being surprised by the market, is to the down side, in
my opinion. This could occur because of a major down grade of US debt, over
supply issues, or Europe sinking further into recession than forecast.
Any break and close below the $78 level pushing down to the
next level of support would cause major pain in the oil market as many models
would be violated by this occurrence.
Once models are violated, all bets are off when it comes to
commodities, and price seemingly goes farther than one would logically predict,
i.e., it is too low to be going down further. This phenomenon causes buyers to
step in trying to catch a falling knife, and their getting stopped out adds
additional fuel to the downside move. If
everybody believes that $75 should hold, and it doesn`t, panic ensues from real
pain in the market, buyers step away altogether, and price can go farther than
you think to the downside.
Market Feel & Technical
Analysis
WTI is a commodity, and commodities adhere more to technical
analysis criterion than other asset classes, but technical analysis is not
perfect or something that can be applied rigidly or religiously. It is just a
tool to be used as a guide with other sources of information like fundamentals,
market sentiment and mechanics, economic reports, consumer and investor trends,
capital flows, geo-politics, OPEC decisions, maintenance and outages, natural
disasters, and other inputs to the oil equation.
But most of all, technical analysis revolves around market
feel for how to apply technical analysis, when it will be violated, when it is
likely to hold, close enough levels, etc.
This ‘market feel’ is the most difficult skill to acquire in the quest
of mastering oil markets.
A successful oil trader has to have a great feel for what
the market is currently doing, and this serves as a solid base for what the
market is likely to do next. The “feel” for how to apply technical analysis is
the ‘art’ in the equation that overlays the ‘science’ of historical pricing
patterns.
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