No one could have imagined a little over four months ago with crude oil trading at $147 that crude oil would have crashed by 70% and be threatening to break below $40 so soon. Therefore, this analysis seeks to evaluate the prospects for crude oil’s future trend over the next 12 months in determining whether crude oil today is a good buy or not.
Crude oil inflation hedge unwinding and the recession
China and other emerging markets are eyeing the fall in crude oil price to utilize huge trade surplus foreign currency reserves to buy up crude oil reserves exposure wherever possible, which has resulted in less of a decline for oil majors’ stock prices despite the 70% oil price crash. Crude oil, as with all asset classes, is being hit by the reversal of the inflation hedging that took place going into mid 2008 that saw crude oil bust through $100 towards $150. The original expectation was for the whole of this inflation hedging to unwind back through $100 and down towards a target of $80 with possible overshoot to the downside once the scale of the credit crisis fully manifested itself. As the oil price rally fed into much higher inflation statistics on the upside, so deleveraging of the inflation hedge is leading to self feeding deflation on the downside, which is acting on pushing crude oil to much lower levels than could originally have been estimated.
The deep recession ensures that crude oil demand is being cut faster than that taken up by the emerging economic giants of China and India, also the stronger dollar has ensured that the actual falls in foreign currency terms has been less than for the United States. This implies continued weak trend for crude oil for the duration of the U.S. recession, which is the key to crude oil’s trend for 2009, which given last months job losses of 533,000 - the worst data in 34 years, illustrates that the U.S. economy is a long way away from recovery with Europe not far behind in terms of economic contraction and, therefore, precludes a quick sustainable recovery for crude oil prices. However, as always, traders and investors need to concentrate on the actual price trend rather than the economic data, as the price will move long before a change in the economic fundamentals becomes apparent.
Strike against Iran rumours
Still, rumours persist of a possible attack against Iran's nuclear infrastructure that will drive crude oil prices higher. These rumours are nothing new, for they tend to pop up every few months and have been doing the rounds for several years. This is more wishful thinking for perma oil bulls that last occurred in the lead up to the crude oil peak of $147 in July 2008, which at the time I concluded of being an extremely low probability event and which remains so. Those that have clung on to crude oil positions on the basis of this rumour have seen their bull market profits totally wiped out, therefore the key for any market participant remains to watch the oil price and not be misled down the path of the wishful-thinking rumour mill.
Crude oil supply/demand fundamentals
According to the International Energy Agency, world oil demand growth is expected to slow to an average of 86.3 mln bpd during 2009, down from earlier forecasts that approached 87 miln bpd. Meanwhile, supply is expected to grow at an annual rate of 1.2% and is expected to hit 87 mln bpd in 2009, which is less than the previous forecast for global supply growth of 1.6% per annum as the supply growth now reflects the 70% crash in the global oil price. However, going forward, demand from developed countries is expected to continue to contract at the average rate of 200,000 barrels per day, which implies the full impact of Peak Oil will be put off for as long as another five years, implying crude oil volatility during this period where a future sentiment driven crude oil bull market could yet again lead to another price crash as we have witnessed over recent months. Therefore, it is important for investors, especially in oil price ETF funds, to always have in place price targets and mechanisms for exiting out of positions so as to ensure future bull market gains do not evaporate in the face of bear markets.
Crude oil technical analysis
Trend Analysis - Crude oil is clearly overshooting to the downside phase, having plunged through the original target of $80, then overshot support at $60, with the final break of the low of $50 and now assaulting on the $40 support level. Further immediate support exists along decades old resistance areas generated during the 1980s in the region of $35. Therefore, this suggests further crude oil downside is limited. However, the deep retracement suggests a wide trading band of between $80 and $35, therefore expectations of much price volatility during the base-building process during much of 2009.
Therefore, those now calling on crude oil to head towards $20 are reminiscent of calls for crude oil to hit $200 earlier this year, the overshoot that was going to occur has occurred with the expectations there is little further downside remaining in future price action. However a bottom has to be formed, which will take time to occur.
MACD - The MACD indicator is extremely oversold, which implies that further immediate downside is extremely limited, which suggests a significant multi-month corrective rally is imminent.
Elliott Wave Theory - The peak of July 2007, marked the 5th wave Crude Oil Bull market peak with the subsequent expected pattern to form an ABC correction that has been confirmed by preceding crude oil bear market outcomes. The current trend lower is clearly an A wave decline, which suggests a B wave rally that could retrace 38.2% of the decline that projects to $80 and confirms trend analysis for a volatile crude oil trading range during 2009.
U.S. Dollar bull market - The trend in crude oil and most commodities is not so surprising in that the Dollar bull market remains in tact, which will continue to bear down on all commodities during 2009. Previous updates: March 2008 - U.S. Dollar bottom called; August 2008 - U.S. Dollar base building breakout; October 2008 - U.S. Dollar correction into late November expected before continuation of the bull market into early 2009 towards a target of USD 92. There will be more to follow on the U.S. dollar's prospects during 2009 in my fourth U.S .Dollar bull market update later this month.
Crude oil forecast 2009
Crude oil is still in a downtrend, which means investors and traders need to WAIT for a buy trigger, which normally means the break of a recent high or a significant resistance area ($50) before scaling into a position, and I mean scaling in because it will take much time for crude oil to formulate a bottom that I expect will form a very volatile double or even triple bottom pattern, i.e. protracted bottom formation punctuated with very sharp short-covering rallies that could see crude oil spike higher to $80 and declines back to below $50 over the next 12 months as the below graph illustrates. What this anticipated scenario means is that there is TIME for investors to buy into crude oil positions as the base building confirmation takes place, as any strong rallies will likely be followed by tests and probable breaks of the previous low so as to enable the creation of the overall saucer shaped double bottom pattern.
However, the long-term trend for crude oil remains higher; when I mean long-term I am looking at well beyond the next 12 months towards five to 10 years, when I would not be surprised given the Peak Oil fundamentals that we will actually be visiting the $200 crude targets that were loudly pronounced during mid-2008 as being imminent when crude oil was trading at $147. This scenario should not be surprising given that the U.S. Dollar bull market remains in tact, which will continue to bear down on all commodities during 2009, but more on the dollar in my next (fourth) U.S. Dollar bull market update.
Gold Quick Update - My previous analysis , which envisioned a sideways trend for gold for 2009 of between $930 and $700, still stands with little price action to date to suggest otherwise. Chris Vermeulen has also prepared an excellent in depth analysis for the outlook for gold and gold stocks trend that readers maybe interest in.
Nadeem Walayat has over 20 years experience of trading derivatives, portfolio management and analyzing the financial markets, including one of few whom both anticipated and Beat the 1987 Crash. Nadeem's forward looking analysis specializes on the housing market and interest rates. Nadeem is the Editor of The Market Oracle, a FREEDaily Financial Markets Analysis & Forecasting online publication. We present in-depth analysis from over 150 experienced analysts on a range of views of the probable direction of the financial markets, thus enabling our readers to arrive at an informed opinion on future market direction. https://www.marketoracle.co.uk
Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilizing methods believed to be reliable, but we cannot accept responsibility for any trading losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors before engaging in any trading activities.