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Crude Oil Forecast: Rebound Heads Towards Overhead Supply

Crude Oil Forecast: Rebound Heads Towards Overhead Supply

2020-05-04 16:00:00
Christopher Vecchio, CFA, Senior Strategist
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Crude Oil Price Forecast Overview:

  • Crude oil prices have been clawing their way higher after the rollover from the May to June WTI contracts, when spot prices dipped into negative territory as US storage facilities proved fully saturated.
  • 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.
  • Recent changes in retail trader positioninggives us a mixed bias towards crude oil prices.
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Crude Oil Prices Continue to Rebound

Crude oil prices have been clawing their way higher after the rollover from the May to June WTI contracts, when spot prices dipped into negative territory as US storage facilities proved fully saturated. But amid signs that developed economies in Asia, Europe, and (hopefully) North America are slowly re-opening, traders are pushing crude oil prices higher in a speculative hope that demand for energy will rebound quickly. As impressive as the recent rebound may be, however, a supply of significant overhead resistance may cap gains soon.

Oil Volatility Slumps, 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. Like 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?

OVX (Oil Volatility) Technical Analysis: Weekly Price Chart (May 2007 to May 2020) (Chart 1)

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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 110.18, 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 is closer to its coronavirus pandemic low (92.48 set on March 10) than it is to the highs.

The 5-day correlation between OVX and crude oil prices is -0.92 while the 20-day correlation is -0.63; and one week ago, on April 27, the 5-day correlation was -0.54 and the 20-day correlation was -0.59. 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)

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It may be the case that crude oil prices have some room to trade higher in the very near-term, but not much beyond a few more dollars higher per barrel. On the CFD contract, the low established during the May WTI contract moving into negative territory was 0. To this end, the Fibonacci retracement taken from the 2020 high at 65.62 to the contract low at 0 suggests that crude oil prices are approaching the 38.2% retracement of the recent move at 25.07.

The overhead resistance area that crude oil prices are approaching cannot be understated. Besides from another important Fibonacci retracement, crude oil prices will need to contend with several important swing lows established over the past decade. Thus, while short-term momentum may be turning more bullish (see: daily MACD and Slow Stochastics), the confluence of resistance nearby suggests that the rally may cool off after a bit more topside action.

Crude Oil Price Technical Analysis: Weekly Chart (March 2003 to May 2020) (Chart 3)

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The longer-term chart highlights the damage done to crude oil prices in recent weeks. The losses around the coronavirus pandemic saw the 11-year symmetrical triangle yield a downside breakout, and crude oil prices have yet to recover in a meaningful manner. Marking a Fibonacci retracement using the high (2011) and low (2020) of the past decade, the 23.6% retracement comes in at 27.10.

Coupled with former support in the symmetrical triangle dating back to the 2009 and 2016 lows, it would appear that crude oil prices are approaching what very well may be the sentimental breaking point for traders: through this resistance, optimism flourishes; failure may be lead to frustrating sideways price action.

IG Client Sentiment Index: Crude Oil Price Forecast (May 4, 2020) (Chart 4)

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Crude oil: Retail trader data shows 51.83% of traders are net-long with the ratio of traders long to short at 1.08 to 1. The number of traders net-long is 9.51% higher than yesterday and 23.21% lower from last week, while the number of traders net-short is 6.79% higher than yesterday and 15.49% higher 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.

Positioning is more net-long than yesterday but less net-long from last week. The combination of current sentiment and recent changes gives us a further mixed crude oil trading bias.

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

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