Clive Maund
gold, silver, & oil shares

Oil Market Update

originally published October 8th, 2013

A few years back there was a lot of talk about “Peak Oil” – how oil production had peaked and the implication was that the oil price was destined to keep climbing in perpetuity in response to endlessly increasing demand from an expanding population as supplies continued to dwindle.

There is an old but true saying that “necessity is the mother of invention” and what has happened is that oil companies have been and are heading off this impending crisis by using the latest technological innovations to make major new discoveries or extend the life of existing fields. Nowhere is this more true than in the US where a combination of new deep water exploration techniques in the Gulf, fracking and oil shale are creating a veritable bonanza that promises to take the US in the direction of oil self-sufficiency by the end of the decade. The downside of this for oil bulls, however, is the possibility of a glut whose potential to depress the price of oil could be magnified by the ever increasing threat of an economic implosion triggered by the debt mountain.

Now let’s move on to see what the charts are saying. The 20-year chart for Light Crude is most interesting as it gives us an overall historical perspective. On this chart we can see that the oil price accelerated into a massive parabolic blowoff move in 2007 and 2008, which was followed by a spectacular bust that was exacerbated by the 2008 financial crisis. After the price bottomed early in 2009 in an extremely oversold state we not surprisingly saw a recovery rally as the price reverted to the mean. The danger here however is that all of the recovery move from the 2008 – 2009 crash lows might be the B-wave of a larger A-B-C bearmarket. If this is the case then a C-wave smash could be right around the corner, which of course implies a MAJOR decline in the stockmarket and a severe recession/depression, that could be brought on as we know by a snowballing bearmarket in bonds and Treasuries driving up interest rates, which would be precipitated by bond holders losing confidence in the US as a result of ongoing Fed irresponsibility manifesting as QE.

The 7-year chart for Light Crude shows the action of recent years in more detail. After a good recovery from the 2008 – 2009 crash lows into early 2011, the price has been spluttering, struggling to make further headway until it tried and failed to get above its 2011 highs on the recent Syrian crisis, which has now cooled. On this chart we can see that a rare Fish Head Triangle formed following the 2011 high. The price broke out upside from this Triangle in the Summer on the Syrian crisis, but the price failed to get above the high of the Triangle, and this breakout is now suspected to be a false one – if it is and the price drops through the 200-day moving average and through the support just below at the apex of the Triangle, a severe decline could ensue.

The 1-year chart for Light Crude shows action this year in detail. We called the top for oil one day after the bearish “shooting star” appeared on its chart at about $112, just before the resolution of the Syrian crisis. The shooting star was caused was insiders in possession of knowledge ahead of the public and even the news media taking positions, before the Russians made the appeasing announcement about handing over the chemical weapons in Syria. The oil price has now dropped back towards a zone of important support at the top of the trading range that developed from January through late June, and above its rising 200-day moving average. This support must hold or things could get rough in a hurry. If the big A-B-C wave theory proves to be correct, then this support will eventually crack, leading to a severe decline. Oil is viewed as a short on any near-term strength, with an overhead stop above the 2011 highs, i.e. above $115.

The oil COT charts are quite strongly bearish with high Commercial short and Large Spec long positions, bearish because the Commercials are generally right and the Large Specs are generally wrong…

In light of the above we should be able to deduce the outlook for the oil sector. Let’s therefore now look at the charts for the XOI oil index, and for ease of comparison use the same time periods for the charts.

The long-term 20-year chart for the XOI oil index frankly looks scary – like it may be have completed the long B-wave recovery prior to a devastating C-wave collapse.

The long-term 20-year chart for the XOI oil index is eerily reminiscent to a very similar chart for silver just before the C-wave smash in September 2011, shown below, which we correctly predicted, although the oil chart is an order of magnitude larger and over a much longer timeframe. The recent new highs for the XOI index certainly look unconvincing.

Also not liked at this time is the fact that the Dow Jones Industrials has arrived at a major trendline target where it is rounding over, which is a logical place for the market as a whole to go into reverse.

Looking at the 7-year chart for the XOI oil index we can see that it has barely dropped back in recent weeks, despite oil reacting, and that we are at an ideal point to short the sector, as it is very close to the resistance at the 2011 highs, so all we need to do is put a close overhead stop above recent highs, and it would probably be wise to be a little generous with placing the stop, putting it above, say, 1450. The creeping advance of recent weeks looks like it is petering out and downside risk is thought to be increasingly rapidly. Note that the negative implications of these charts apply to the oil majors and mid-caps, the junior exploration stocks that we have recently featured on the site move for their own reasons and are not hostage to sector indices to anywhere near the same extent that the larger oil stocks are. Most of these oil juniors have already suffered devastating bearmarkets and are trading at extremely low prices. In fact, shorting the majors and buying the most promising exploration stocks looks like a good way to play this sector.

The 1-year chart for the XOI index shows the recent creeping advance in detail and how it looks like some sort of rounding top and also has some characteristics of a bearish Rising Wedge. It is still very near recent highs and so at a good point to short, and with the price and the 50 and 200-day moving averages now increasingly bunched together, it could snap rapidly to the downside. While we cannot entirely rule out another upleg, it is looking unlikely, especially as upside momentum is waning, as made clear by the descending line of tops on the MACD indicator at the bottom of the chart.

Finally, the oil sector appears to have been slowly deteriorating relative to the market as a whole for a long time now, as shown by this 20-year chart of the XOI oil index over the S&P500 index, which shows a relative top area that is close to breaking down. If it does break down oil stocks could drop hard and it will probably happen at a time when the broad market itself is falling, but oil stocks are falling faster.

End of report