Crude oil could be near the bottom

The plunging crude oil prices have been dominating the headlines. It is not just the price collapse itself, but also the wider implications that this has had that have garnered a lot of attention. Among other things, for example, crude’s collapse has helped to fuel a currency crisis in Russia while also weighing heavily on currencies of other oil producing nations such as Canada and Norway. What’s more, it has raised deflation risks across the major economies, especially in the euro area, which is part of the reason why the stock markets have sold off in recent times. Concerns about deflation have also weighed on demand expectations for oil itself, thus sending it in a vicious cycle. Indeed, crude’s drop earlier today was probably a reflection of the concerns about demand from emerging markets in particular: overnight we saw the HSBC’s Chinese manufacturing PMI dipped below the expansion threshold of 50 for the first time in seven months. This followed below-forecast trade and inflation figures last week, raising both growth concerns and expectations about more stimulus measures form the PBOC. In Russia, the central bank hiked interest rates to a whopping 17% as it attempted to halt the Ruble’s colossal collapse. The weaker currency and high rates of interest will likely weigh heavily on economic growth in Russia which in turn may have some negative impact on demand for crude.

Nevertheless, crude oil found some much-needed support in the afternoon as speculators probably booked profit ahead of the weekly oil inventory reports from the API and EIA, and after realising that today’s Eurozone PMIs were actually not as bad as some had feared. In fact, the German manufacturing PMI swung back to expansion with a print of 51.2, easily beating expectations of 50.4. On top of this, the German ZEW survey also surprised to the upside, suggesting investors may not be too concerned about deflation risks after all. However, the slighter weaker US data dampened the bulls’ enthusiasm and as a consequence oil prices halted their rally later in the afternoon.

Although it is too early to call a bottom for oil, speculators know that there is so much more the commodity could fall. Given the parabolic-like nature of the price slide, it is inevitable that the trend will come to a halt soon and when it does there could well be a sharp counter-trend move as speculators scramble to cover their short positions. Anticipating this, speculators are likely to proceed with extreme caution, especially as the price of oil has now halved since June. In fact, some have even been increasingly their bullish holdings, probably as a result of the “cheaper” prices. According to the latest positioning data from the ICE and CFTC, net long positions in both Brent and WTI contracts have increased by more than 5 thousand contracts last week. Bullish positions in Brent are now at their highest level since August.

Since breaking out of its bearish channel to the downside, Brent has done exactly what should have been expected of it: accelerated its down move. The manner in which it has since fallen suggests there have been very little further attempts from bullish speculators to try and pick the bottom, for the daily candles have had very small or no wicks at all. Clearly, the lack of bids has been partially responsible for the acceleration in the downward trend. This type of a move makes me wonder whether a bottom is now in sight. But until such a time that we see a clear reversal signal, such as a double bottom or a false breakout pattern, the path of least resistance remains to the downside. Likewise WTI remains in a bearish trend until proven wrong. For the US oil contract, the next major level of support is around $50 – this being a psychological level which also roughly corresponds with the 78.6% Fibonacci level of the entire 2008-11 rally.

Figure 1:

Source: FOREX.com. Please note this product is not available to US clients.

Figure 2:

Source: FOREX.com. Please note this product is not available to US clients.