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Crude Oil Price Forecast: Post-Breakout Flag Builds - Levels for Crude Futures

Crude Oil Price Forecast: Post-Breakout Flag Builds - Levels for Crude Futures

Christopher Vecchio, CFA, Senior Strategist
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Crude Oil Price Forecast Overview:

  • Crude oil prices have been trading sideways for the past week, continuing the flag that was identified in the prior update.
  • The ongoing tug-and-pull between the global economic recovery and the supply-demand deficit remains the prevailing overarching theme guiding energy markets.
  • Recent changes in retail trader positioning gives us a bearish bias towards crude oil prices.

Crude Oil Prices Deal with Supply Narrative

Crude oil prices have not produced significant advances in recent days, with the gains seen at the end of November and the first days of December giving way to stagnation. News that OPEC+ would begin to scale back their production cuts from 8.2 million bpd to 7.7 million bpd starting on January 1, 2021 has reminded the market of the ongoing tug-and-pull between the global economic recovery and the oil supply-demand deficit, which remains the prevailing overarching theme guiding energy markets.

In recent days, the Dallas Fed put forth its energy survey, in which its respondents said that the breakeven price for new wells varies between $46 and $52 per barrel. Overall, the tenets from the Q3’20 crude oil forecast remain valid, which we highlighted in the prior crude oil price forecast update. Accordingly, the crude oil sideways trade may continue; and even a bullish breakout may have trouble gathering traction.

Crude Oil Price Technical Analysis: Daily Chart (December 2019 to December 2020) (Chart 1)

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Crude oil prices are continuing to flag following their bullish breakout from the August to November range/descending channel. As noted in the previous update, the measurement of the range from support to resistance, taken from the breakout point, suggests that the bullish breakout target may have been reached. In the last update it was noted that these observations led to the conclusion that “the upside move has already been exhausted,” which after several more days of range trading, appears accurate.

It’s still the case that the outcome of this sideways struggle crude oil prices are enduring will ultimately shape the next directional move.

If crude oil prices were to make any more gains, breaching 46.26 could trigger what could be a quick trip higher into the area between 48.66 and 49.31, which proved to be a meaningful turning point in February and March during the initial coronavirus pandemic selloff. Coupled with the knowledge that significant overhead supply sits on the sideline, any gains into the 48.66 and 49.31 would be seen as the absolute point for profit taking for bulls.

Oil Volatility Slumps, Oil Prices Inch Higher

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; signs that the global economy is recovering from the coronavirus pandemic reduces uncertainty, as does hope for a new US fiscal stimulus package.

OVX (Oil Volatility) Technical Analysis: Daily Price Chart (December 2019 to December 2020) (Chart 2)

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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 38.28, its lowest level since mid-September. Oil volatility remains far below the yearly absolute high (incidentally the all-time absolute high) set on April 21 at 517.19, and still considerably below the yearly closing high (incidentally the all-time closing high, also established on April 21) at 325.15. Oil volatility is back at levels seen throughout 2019; the situation appears to be stable (as has been the case since June).

The 5-day correlation between OVX and crude oil prices is -0.76 while the 20-day correlation is -0.68; and one week ago, on December 1, the 5-day correlation was -0.29 and the 20-day correlation was -0.79. If it’s typical to see oil volatility and oil prices share an inverse relationship, a sense of normalcy has been in place for quite some time: today is the first day since August 12 that the 20-day correlation has risen back above -0.70.

IG Client Sentiment Index: Crude Oil Price Forecast (December 8, 2020) (Chart 3)

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Oil - US Crude: Retail trader data shows 49.71% of traders are net-long with the ratio of traders short to long at 1.01 to 1. The number of traders net-long is 1.25% higher than yesterday and 8.39% higher from last week, while the number of traders net-short is 5.97% lower than yesterday and 4.65% lower from last week.

We typically take a contrarian view to crowd sentiment, and the fact traders are net-short suggests Oil - US Crude prices may continue to rise.

Yet traders are less net-short than yesterday and compared with last week. Recent changes in sentiment warn that the current Oil - US Crude price trend may soon reverse lower despite the fact traders remain net-short.

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

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

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