Crude Oil Prices Struggle After Dual Crises, but Long-term Bullish Potential Remains
Crude Oil Outlook:
- It’s been an interesting few weeks for energy markets, between the record cold spell that froze over Texas to the blockage of the Suez Canal. Now that these mini-crises are behind us, crude oil prices have lost near-term bullish catalysts.
- Accordingly, the recent bullish breakout attempt above the descending trendline from the July 2008 (all-time high) and June 2014 highs has thus far failed. However, a look at the weekly timeframe shows buying interest remains, suggesting another attempt higher soon may arrive.
- Recent changes in retail trader positioning suggests a bearish bias towards crude oil prices.
Crude Oil Prices Ease Off
Crude oil prices had a strong start to the year, in part energized by two swans: the record cold spell that froze over Texas and the blockage of the Suez Canal. It’s been an interesting few weeks, but now that these mini-crises are in the rearview mirror, some of the recent bullish catalysts (supply constraints) have been lost. Yet even as crude oil prices remain largely directionless for the past few weeks, failing in their initial bullish breakout attempt above the descending trendline from the July 2008 (all-time high) and June 2014 highs, longer-term technical studies continue to suggest that bulls haven’t thrown in the towel just yet.
Relationship Between Oil Volatility and Oil Prices Appears Normal
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; signs that the global economy is recovering from the coronavirus pandemic reduces uncertainty, and thus, volatility.
OVX (Oil Volatility) Technical Analysis: Daily Price Chart (April 2020 to April 2021) (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) closed out the week at 41.18. Oil volatility is back at levels seen throughout 2019; the situation has been and appears to be poised to remain stable, as has been the case for most of the past nine-month (discounting volatility leading into the US elections in November).
With oil volatility trading sideways, and crude oil prices in a general uptrend, the correlations we monitor remain normalized (in excess of -0.50). The 5-day correlation between OVX and crude oil prices is -0.61 while the 20-day correlation is -0.51; and one week ago, on March 31, the 5-day correlation was -0.72 and the 20-day correlation was -0.67.
Crude Oil Price Technical Analysis: Daily Chart (April 2020 to April 2021) (Chart 2)
Crude oil prices are no longer the ascending channel that defined price action since the November 2020 low (incidentally the first trading day of the month), having fallen through channel support in mid-March and failing to stage a recovery thus far. This drop also constituted a drop below the descending trendline from the July 2008 and June 2014 highs, suggesting a false bullish breakout (more on that below).
But even with the drop in crude oil prices, momentum has shifted from bullish to neutral, but not to bearish. Crude oil prices are intertwined among their daily 5-, 8-, 13-, and 21-EMA envelope, which is in neither bearish nor bullish sequential order. Daily MACD is hugging its signal line, while daily Slow Stochastics continue to trickle towards oversold territory. It remains to be seen if price action over the past two weeks is a bear flag or simply bulls finding their footing anew.
Crude Oil Price Technical Analysis: Weekly Chart (December 2007 to April 2021) (Chart 3)
In the first of two weekly charts, we see that there has been a failed bullish breakout above the descending trendline from the July 2008 and June 2014 highs. Crude oil prices were only above this trendline for two weeks on a closing basis, and concerningly, the three-week stretch around the failed breakout appears to have taken the shape of an evening star candle cluster, a topping pattern.
Crude Oil Price Technical Analysis: Weekly Chart (December 2013 to April 2021) (Chart 4)
Yet when we take a closer look at the weekly timeframe, we see that the ensuing periods post-evening star candle cluster have failed to produce follow through to the downside, with several hammer candles forming thereafter. The long weekly wicks speak to strong demand in the market right at the weekly 13-EMA, which is effectively a moving average of the past one quarter of price action. Only if the weekly 13-EMA breaks on a closing basis would the perspective shift from neutral to bearish. For now, we remain open to a return back to a bullish breakout opportunity above the multi-year descending trendline.
IG CLIENT SENTIMENT INDEX: CRUDE OIL PRICE FORECAST (April 7, 2021) (CHART 5)
Oil - US Crude: Retail trader data shows 68.95% of traders are net-long with the ratio of traders long to short at 2.22 to 1. The number of traders net-long is 13.69% higher than yesterday and 20.34% higher from last week, while the number of traders net-short is 11.93% lower than yesterday and 12.12% lower from last week.
We typically take a contrarian view to crowd sentiment, and the fact traders are net-long suggests Oil - US Crude 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 Oil - US Crude-bearish contrarian 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.