Is The Oil Price Topping?

• Oil experiences a major upside breakout
• Overstretched energy markets on a short-term basis
• Where oil goes commodities in general often follow

I recently came across a commitment of traders hedgers chart that shows a record low short position. Now it’s true that since the 1990’s  there has been a secular decline in these numbers, as the use of futures contracts has become more and more popular.  However, when expressed as a deviation from trend the latest plot was also at a record low. If these traders were usually incorrect in their assessment that would be extremely bullish, but the fact is, that they are usually far more right than wrong at important turning points, which is a troubling factor. Generally speaking, the trend of this data is just as important as its level. In other words, as long as these smart traders continue to expand their short positions the oil rally is safe. However, when it finally reverses, it’s for the bulls to get worried.

Oil experiences a major upside breakout

On the face of it, calling a top in oil does not seem to make much sense. Chart 1 for instance, shows that West Texas Crude has recently completed and broken out from a large inverse head and shoulders. That formation is not even close to its indicated objective flagged by the blue horizontal trendline. Moreover, the long-term KST is in a rising trend, not to mention the expanding global economy, which continues to boost demand.

Chart 1

This action is also being confirmed by the price of Brent crude as featured in Chart 2. Clearly the main trend is up and we need to respect that. Nevertheless, markets are a reflection of people in action and people can and certainly do change their minds. Consequently, it is always possible that the breakout could turn out to be false. If the commitment of traders and recent sentiment numbers for the various energy categories were not so high I would not entertain such an idea. However, rampant bullish sentiment amongst traders suggest that the breakout scenario is likely to be tested. If that happens, the benchmark we need to watch on Chart 1 is $50 on the continuous contract, because that is where the 65-week EMA and the two converging trendlines will soon be intersecting. The $50 level represents two things, massive support and a very important number psychologically.

Chart 2

Unleaded Gas, in Chart 3, has also broken to the upside, but is having trouble maintaining the breakout. The real test would come if the bearish short-term KST causes it to drop below the red 2016-17 up trendline and 200-day MA, both of which are around the $1.60 level. Were that to happen it would confirm the October breakout as a whipsaw, probably resulting in a nasty decline.

Chart 3

Overstretched energy markets on a short-term basis

Chart 4 tells us that the iPath Crude Oil ETN, the OIL, is still in an uptrend, but the KST has recently gone bearish from an overbought reading. This suggests that a short-term correction of some kind is in the air. How the price handles it will help validate the breakouts that have already developed in the long-term charts. Right now, the short-term trend is a rising one, but a break below the red up trendline would probably signal that some ranging action or price erosion had begun.

Chart 4

Chart 5 is interesting. That’s because it tells us that volume was shrinking on the latter part of the recent rally. We can see this from both the declining histogram and the very oversold reading in the PVO in the bottom window. That reading suggests one thing, that volume is likely to pick up. Rising activity can be bullish or bearish, depending on the direction of prices. Expanding volume in late October was bullish, because it developed on the upside. See the green arrow. This expanding volume also coincided with a rising KST as flagged by the green arrow in Chart 4. Now, however, the KST is bearish and overbought, so it would seem likely that volume will be expanding as prices correct, and that’s generally a bearish omen.

Chart 5

Oil versus the oil shares

The relationship between the oil price and the oil share ETF’s is not as close as that between, say gold and gold shares, so we need to be careful in drawing extreme conclusions from this relationship. In this respect, Chart 6 compares the progress of the OIL to the SPDR Energy ETF, the XLE. Sometimes it is possible to construct trendlines for both series and when jointly violated a (usually reliable) short-term trend reversal signal is given. We see a bullish example in mid-September. The chart also shows that a negative divergence between the two series developed earlier in the year. In that respect, the latest oil price high has not been confirmed by the shares. Indeed, the XLE looks very much as if it is in the process of completing a small head and shoulder top.  The two benchmarks to monitor in this regard are $6 for the OIL and $66 for the XLE.

Chart 6

Where oil goes commodities in general often follow

Because oil is such an important commodity its price swings often influence broadly based commodity ETF/s such as the DB Commodity ETN, the DBC. You can see this from Chart 7 which compares the recent past of both series.

Chart 7

Chart 8 offers and excellent example of why it’s important to wait for false breakouts to be confirmed by additional price action. Back in October, the price broke above the green trendline but never experienced that confirmation as it then proceeded to move higher. Currently, the KST is in a negative mode but the trend, like that for oil, remains positive. The key would be a break below the previous low at $16. Until then, we should assume that the trend is positive.

Chart 8

Finally, Chart 9 shows that the DBC recently experienced a buying climax as the price rally was accompanied by a very high reading in the PVO, which has subsequently subsided. The three previous buying climaxes were each followed by a decline. Now that volume has subsided to a far more subdued level it is likely to rally. Since, the previous chart shows that the KST is currently overbought and bearish, it would seem that any expansion of activity will take place on the downside, thereby possibly invalidating the breakout above the green trendline. The benchmark to follow in this regard is $15.75, which would take the price below the red up trendline and the 50-day MA.

Chart 9

In conclusion, the recent major breakout by the oil price should be treated as valid. However, some near-term technical negatives combined with some extreme readings in the commitment of traders reports suggest we should keep a watchful eye on the situation.

Good luck and good charting,
Martin J. Pring

The views expressed in this article are those of the author and do not necessarily reflect the position or opinion of Pring Turner Capital Group of Walnut Creek or its affiliates.