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Weekly Crude Oil Technical Forecast: Livin’ on a Prayer

Weekly Crude Oil Technical Forecast: Livin’ on a Prayer

Christopher Vecchio, CFA, Senior Strategist

Fundamental Forecast for the Crude Oil: Neutral

- Energy markets have continued their impressive rebound since mid-April price plunge, all revolving around the notion that the global economy is about to get up and running soon.

- Signs that the US economy is starting to re-open has relieved concerns that the supply glut would remain through the summer, typically the highest demand period for oil in the US.

- The IG Client Sentiment Index suggests that crude oil prices may not continue to rally for much longer.

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Crude Oil Prices Week in Review

Energy markets have continued their impressive turnaround in May, with crude oil prices closing the week out at their exact highs. The rebound since the mid-April plunge has revolved around the central concept that the worst of the coronavirus pandemic is behind us, and that demand for energy will rebound amid a re-opening of the global economy. To this end, the -22% collapse in oil volatility (as measured by OVX) was met by a +19.3% gain by spot crude oil prices.

Economic Calendar Week Ahead Impact on Crude Oil Prices

Traders looking to the economic calendar for meaningful data with respect to energy markets may be disappointed, beyond the usual weekly inventories figures and the weekly US initial jobless claims report (which has had a more meaningful impact on price action than the hallowed NFP report). A lighter economic calendar in the middle of the month is typical, so traders may only find the slew of incoming inflation data from Canada, the Eurozone, and Japan as market moving with respect to energy prices over the coming days.

Oil Volatility Continues Pullback as Oil Prices Rally

Crude oil prices have a relationship with volatility like most other asset classes, especially those that have real economic uses – other energy assets, soft and hard metals, for example. Similar to how bonds and stocks don’t like increased volatility – signaling greater uncertainty around cash flows, dividends, coupon payments, etc. – crude oil tends to suffer during periods of higher volatility. Heightened uncertainty in financial markets due to increasing macroeconomic tensions decreases theoretical demand for energy; The Great Lockdown has yielded the weakest demand environment for energy since World War II.

Read more: How Do Politics and Central Banks Impact FX Markets?

Crude Oil Volatility Technical Analysis: Daily Chart (March2008 to May 2020) (Chart 1)

Oil volatility (as measured by the Cboe’s gold volatility ETF, OVX, which tracks the 1-month implied volatility of oil as derived from the USO option chain) was last spotted trading at 76.39, well off of its all-time absolute high set on April 21 at 517.19, and still considerably below the all-time closing high (also established on April 21) at 325.15. Oil volatility has broken down through its initial coronavirus pandemic low (92.48 set on March 10) and continues to trend lower.

The 5-day correlation between OVX and crude oil prices is -0.79 while the 20-day correlation is -0.58; and one week ago, on May 8, the 5-day correlation was 0.21 and the 20-day correlation was -0.51. If it’s typical to see oil volatility and oil prices share an inverse relationship, it would appear that this sense of normalcy is returning: a continued drop in oil volatility may allow for further near-term gains by crude oil prices, even if the scope of a significant recovery remains limited.

Crude Oil Price Technical Analysis: Daily Chart (May 2019 to May 2020) (Chart 2)

Crude oil prices have charged through the 2016 low at 26.05, making their way towards the 2009 low set at 33.55. This area of resistance area that crude oil prices are approaching cannot be understated. Besides Fibonacci retracements from the 2018 high/2020 low range coming into play, it’s more critical that crude oil prices will need to overcome several important swing lows established over the past decade and beyond (2009, 2016, 2017, and 2018). Thus, while short-term momentum has become more bullish (see: daily MACD and Slow Stochastics), traders should stay cautious that, given the volatility backdrop, sharp price swings to the downside can’t be ruled out.

IG Client Sentiment Index: Crude Oil Price Forecast (May 15, 2020) (Chart 3)

Crude oil: Retail trader data shows 55.49% of traders are net-long with the ratio of traders long to short at 1.25 to 1. The number of traders net-long is 42.60% higher than yesterday and 5.08% lower from last week, while the number of traders net-short is 3.08% lower than yesterday and 5.93% lower from last week.

We typically take a contrarian view to crowd sentiment, and the fact traders are net-long suggests crude oil prices may continue to fall.

Traders are further net-long than yesterday and last week, and the combination of current sentiment and recent changes gives us a stronger crude oil-bearish contrarian trading bias.

Latest COT Data Shows Oil Longs Ease

Finally, looking at positioning, according to the CFTC’s COT for the week ending May 12, speculators increased their net-long Crude Oil positions to 540K contracts, up from the 530.6K net-long contracts held in the week prior. Net-longs have continued to retain significant exposure since the spot price of crude oil dropped into negative territory in April. Nevertheless, crude oil net-long positioning remains far below the highs seen over the past two years, when 739.1K net-longs were held during the week ending February 6, 2018.

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--- Written by Christopher Vecchio, CFA, Senior Currency Strategist

DailyFX provides forex news and technical analysis on the trends that influence the global currency markets.