THE BOTTOM FOR CRUDE OIL

by Frank Barbera

Back on July 25^th of this year, I wrote a piece for the Market WrapUp updated July 25^th (see archives) wherein I talked about a stock market bottom (in a series of articles) and a potential top in Crude Oil. In that article, I noted that on a longer-term trend basis, the new series of higher highs in Crude Oil, were showing many signs of failing momentum. Momentum measures the force underpinning any advance in price and when prices are advancing against the backdrop of declining momentum, it is usually only a matter of time before they roll over in slide in a large correction.

In the case of Crude Oil, I showed the chart below with the Weekly Oil chart and the Weekly RSI. RSI is a normalized momentum indicator, meaning it measures the degree of momentum within a market and attempts to reflect the underlying forces on a fixed or normalized scale. This is a different approach then say, Moving Average Convergence-Divergence (MACD), another popular momentum indicator, which uses a non-bounded scale and can be equally effective. Back on July 25^th, the technical picture of Crude Oil showed a classic 5 wave advancing pattern coming to a peak with the 5^th wave, showing hallmark signs of steadily weakening figures on the RSI.

As it turned out, those negative momentum divergences continued to play out and in another report issued on Wednesday September 13^th with Crude Oil at $68 per barrel, I pointed out a double top in Crude Oil noting, that Crude Oil was “in close proximity to key support near the $68.40 level (see next chart)”. At the time, I stated, “...the potential that a downside break below $68.40 could quickly lead to a bout of serious follow thru downside action, with Oil’s next major support being in the high $50’s."

Ultimately, I “sketched in” and set a downside target on a breakdown of $57 dollars for Crude, which on the nearby chart appeared to be a strong, longer range support. More recently, in my October 3^rd newsletter update, I included yet another chart of Crude Oil, this time an hourly chart telling readers that Crude still had a bit further to go – near term, on the downside.

Using Elliott Wave analysis, (not shown on chart), I produced the following graph with Crude Oil at $58.80 at the time. In the report, I explained that Oil (1) need to rally toward $62 and then needed a second and final decline to a lower low near the $57.50 to $58 range, which at that point should mark the final low of the larger decline (see next chart). Updating that chart to the present time period, we find that the anticipated “bottoming sequence” for Crude Oil has taken shape right along the proper outline, with prices having rallied to a high of $61.49 on October 9^th, followed by a decline to a low yesterday at $57.30.

While I still cannot rule out prices lingering in this area for another day or two, the overall appearance of the Oil chart is now that of a major bottom, with the initial recovery off the low, very likely to lift prices back up into the $64 to $66 dollar range over the next few weeks.

Above: the Hourly Chart forecast for Crude Oil on October 3^rd with projected rally to $62 and then decline to $58, and

Below: the actual outcome which followed the estimate on both price and time

Ironically, listening to cheerleaders on “BubbleVision” and the plethora of one-sided, “Energy Analysts” appearing thereon, the sentiment toward Crude Oil is now universally bearish with commentator after commentator forecasting $50, $45, or even $35 Oil over the next few months.

While it is true that Oil inventories are presently at very high levels, it is also true that:

1. marginal capacity for Oil is extremely constrained, (Capacity Utilization at 97%, not 75% or 78% as in the 80’s and 90’s),

2. global demand with China adding 180,000 new cars to the road PER week is well embarked on a new secular rise, and

3. unlike the 1980s or 1990s when OPEC Oil cuts were ineffective in putting a “floor” under Oil, in the new reality of the 21^st century, [accelerating global consumption cast against the backdrop of “virtually zero” spare capacity and the even larger specter of “Peak Oil” starting this year] OPEC is highly empowered and even small production cuts will rapidly shore up prices.

Bottom Line:

The odds of anything less then $55 Crude Oil seem very far removed -- recession or no recession. In my view, the outlook for a solid recovery in Energy prices for this point forward seems like a very high probability event. For Crude Oil any move back above $60 will confirm that a major bottom has been seen.

Technically, Crude Oil is now showing pronounced positive divergences on both the daily and hourly charts and is set up against the backdrop of major, long-term support at the 200-day lower band between $57 and $58. With the Medium Term RSI very oversold, odds are high that Oil should rally back up across the entire range over the next few months with prices back above $70 quite likely.

On a pure Elliott basis, a multi-month rally back up across the range toward the mid-$70’s would likely develop as the “B” Wave of a larger unfolding “A-B-C” correction. Under this outcome, the price of Crude Oil could establish a high level trading range over the next 12 months between $57 and $75, averaging out at around $68 per barrel.

On the longer-term chart shown above, I note that the 9 week RSI – a very medium-term gauge – is fully oversold below +30. Over the balance of the last few decades, these kinds of readings have always put a floor under Oil prices for at least a few months, if not accompanied major lows.

In my view, the above outlook is reasonable for a slow growth economy and would likely be quite conservative if geopolitical tensions begin to increase with either Iran or North Korea. For the Oil Bears and Short Sellers, now would be a good time to think twice.

Frank