Crude Oil Outlook:
- Crude oil prices have swung violently around Russia-Ukraine headlines, and will likely do so for the foreseeable future.
- There still hasn’t been a close below the daily 21-EMA (one-month moving average) since December 21, 2021.
- According to the IG Client Sentiment Index, crude oil prices have a bullish bias in the near-term.
Not Quiet on the Eastern Front
The Russia-Ukraine conflict has provoked significant volatility in energy markets, and the net-result may be bullish for crude oil prices. As previously noted, there is “a speculative supply-demand imbalance that could see global energy demand outstrip supply in a meaningful manner should the war of words escalate into boots on the ground.”
New American and European sanctions towards Europe will only constrain global energy supplies, with no corresponding downdraft in demand – particularly if Russia doesn’t advance further than the Donestk and Luhansk regions. The global economic backdrop, regardless of what’s transpiring on Europe’s eastern front, remains quite strong, suggesting demand for energy will build in the coming months.
Our fundamental outlook is thus unchanged: “with influences on both the demand and the supply side likely to remain along their current trajectory for the foreseeable future, the fundamental argument for higher oil prices remains intact, alongside a continued bullish outlook from the technical perspective.”
Oil Volatility, Oil Price Correlation in Disarray
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. But heightened geopolitical tensions are throwing off the typical relationship between oil prices and oil volatility.
OVX (Oil Volatility) Technical Analysis: Daily Price Chart (February 2021 to February 2022) (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 trading at 51.96 at the time this report was written. The short-term correlation has deteriorated as oil prices have charged higher while oil volatility has plateaued. The 5-day correlation between OVX and crude oil prices is -0.70 while the 20-day correlation is +0.28. One week ago, on January 20, the 5-day correlation was +0.83 and the 20-day correlation was +0.14.
Crude Oil Price Technical Analysis: Daily Chart (November 2020 to February 2022) (Chart 2)
Crude oil prices are working on a daily doji candle after a wide trading range emerged following the US holiday weekend. Nevertheless, the bulls remain in control despite a meaningless setback from fresh yearly highs last week; crude oil prices have closed above their daily 21-EMA every session starting on December 22, 2021. Overall, crude oil prices are above their daily 5-, 8-, 13-, and 21-EMA envelope, which remains in bullish sequential order. Daily MACD is pulling back but remains above its signal line, while daily Slow Stochastics are nearing their median line. It’s notable that while momentum indicators have dipped, crude oil prices have not; this is a bullish divergence. A move back to the yearly high at 95.82 may be around the corner.
Crude Oil Price Technical Analysis: Weekly Chart (January 2008 to February 2022) (Chart 3)
At the end of January it was noted that “crude oil prices have cleared several key levels of technical resistance in recent days. With crude oil prices above their weekly 4-, 8-, and 13-EMA envelope, which is in bullish sequential order, traders may eye further gains…this view has been strengthened through the first three weeks of the year, and traders may be well-suited to continue to look for further crude oil strength in the near-term.” Nothing has changed, and the longer-term technical outlook remains bullish.
IG CLIENT SENTIMENT INDEX: CRUDE OIL PRICE FORECAST (February 22, 2022) (CHART 4)
Oil - US Crude: Retail trader data shows 39.52% of traders are net-long with the ratio of traders short to long at 1.53 to 1. The number of traders net-long is 6.16% lower than yesterday and 7.14% lower from last week, while the number of traders net-short is 1.72% higher than yesterday and 3.69% higher 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.
Traders are further net-short than yesterday and last week, and the combination of current sentiment and recent changes gives us a stronger Oil - US Crude-bullish contrarian trading bias.
--- Written by Christopher Vecchio, CFA, Senior Strategist
