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Crude Oil Price Forecast: Drops from Resistance to Trend Support - Levels for Crude Futures

Crude Oil Price Forecast: Drops from Resistance to Trend Support - Levels for Crude Futures

Christopher Vecchio, CFA, Senior Strategist

Crude Oil Price Forecast Overview:

  • After a strong run through the first three weeks of the month, crude oil prices have pulled back sharply ahead of the holidays.
  • Concerns that the new strain of coronavirus emerging from the UK has introduced a new bout of uncertainty into markets, boosting volatility and sinking crude oil prices.
  • Recent changes in retail trader positioning gives us a mixed bias towards crude oil prices.

Crude Oil Prices Follow Risk Trends

After a strong run through the first three weeks of the month, crude oil prices have pulled back sharply ahead of the holidays. Down by over -5% earlier, crude oil prices have followed broad risk trends throughout the day, tracking movements in both global equity markets and energy-sensitive currencies like the Canadian Dollar. Concerns that the new strain of coronavirus emerging from the UK has introduced a new bout of uncertainty into markets, boosting volatility and sinking crude oil prices.

But with calming tones from executives at pharmaceutical companies involved in the development of the coronavirus vaccines, suggesting that the recent mutation won’t reduce the efficacy of the vaccines developed by Pfizer/BioNTech and Moderna, it’s too soon to say that the latest news won’t come to pass. Indeed, with the holiday season in full swing, the pullback in crude oil prices may be in part spurred – exacerbated – by early end-of-year profit taking.

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

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In the last update, it was noted that “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.

At the end of last week, crude oil prices closed at 49.43 (where the weekly begins for this week). From my perspective, that we’ve seen a pullback in crude oil prices makes total sense, insofar as key resistance was reached ahead of a holiday period; there are sound technical reasons for profit taking, regardless of the news flow.

To this end, the crude oil price selloff has stopped at a familiar trend level, the daily 13-EMA, which has held up on two prior occasions in December thus far. Daily MACD continues to trend higher in bullish territory, while daily Slow Stochastics remain overbought. Achieving key topside targets in the recent bullish breakout attempt may dictate a period of digestion for crude oil prices, not a meaningful bearish reversal.

Oil Volatility Up, but Sideways in General

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 latest news of a new strain of the coronavirus emerging in the UK has introduced a new bout of uncertainty to markets, energy or otherwise.

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 42.76, 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 has jumped to its highest level since December 2.

The 5-day correlation between OVX and crude oil prices is -0.78 while the 20-day correlation is -0.60; and one week ago, on December 1, the 5-day correlation was +0.67 and the 20-day correlation was -0.61. The relationship between crude oil prices and volatility remains historically weak, however: the 20-day correlation is at its least significant reading since August 11.

IG Client Sentiment Index: Crude Oil Price Forecast (December 21, 2020) (Chart 3)

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Oil - US Crude: Retail trader data shows 44.26% of traders are net-long with the ratio of traders short to long at 1.26 to 1. The number of traders net-long is 8.26% higher than yesterday and 14.10% lower from last week, while the number of traders net-short is 13.15% lower than yesterday and 6.82% 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.

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

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

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