Crude Oil Outlook:
- Crude oil prices dropped sharply last week, but a bullish triangle – a continuation effort – lingers, suggesting more upside may be ahead.
- The fundamentals haven’t changed: global demand continues to outstrip supply, despite growing concerns about recessionary conditions setting in.
- According to the IG Client Sentiment Index, crude oil prices have a mixed bias in the near-term.
Recession Concerns Weigh
The June Federal Reserve policy meeting was a wake-up call for market participants, who have quickly come to terms with the idea that the only way for central banks to restrain inflationary pressures is through demand destruction. After all, not the Fed, nor the European Central Bank, nor the Bank of Japan – or any central bank for that matter – can fix global supply chains upended by Russia’s invasion of Ukraine or China’s zero-COVID strategy.
This abrupt realization last week sent risk appetite tumbling, from equity markets to growth-linked commodities like copper and oil. But those concerns may be overhyped in the near-term, as global demand for energy continues to grow – for now – in the face of a lackluster rebound in supplies. OPEC+ countries may not be able to increase production enough to meet projected estimates, and the only viable hope for demand destruction over the coming months is for China to reinstitute sweeping zero-COVID mandates.
Oil Volatility, Oil Price Correlation Remains Weak
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. The recent uptick in oil volatility coincided with a downturn in crude oil prices, as is the historical norm.
OVX (Oil Volatility) Technical Analysis: Daily Price Chart (June 2021 to June 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 49.19 at the time this report was written, nearly at a fresh monthly closing high. The 5-day correlation between OVX and crude oil prices is -0.66 while the 20-day correlation is -0.65. One week ago, on June 13, the 5-day correlation was -0.30 and the 20-day correlation was -0.71.
Crude Oil Price Technical Analysis: Daily Chart (October 2020 to June 2022) (Chart 2)
Crude oil prices were slammed lower after trading to their highest levels since early-March, ultimately moving back below the 100% Fibonacci extension level (114.20) measured from the November 2020 low, October 2021 high, and December 2021. But the technical structure may still be bullish, as a multi-month triangle appears to have formed: resistance is against the March and June swing highs; and support is against the November 2021, April 2022, and May 2022 swing lows. Further consolidation may be afoot for the next few weeks as price action winnows into the apex of the symmetrical triangle, which in context of the preceding move, still calls for fresh cycle highs in crude oil prices by mid-summer.
Crude Oil Price Technical Analysis: Weekly Chart (March 2008 to June 2022) (Chart 3)
On the weekly timeframe, bullish momentum has stalled. Crude oil prices are below their weekly 4-EMA, sitting right at their weekly 8-EMA, and remain above their weekly 13-EMA. The EMA envelope remains in bullish sequential order, however. Weekly MACD is has started to decline while well-above its signal line, and weekly Slow Stochastics are beginning to pullback towards their median line. Concurrent with the daily timeframe analysis, the weekly timeframe suggests a period of consolidation may be ahead; the range could form between 107.00 and 122.00, or thereabouts.
IG CLIENT SENTIMENT INDEX: CRUDE OIL PRICE FORECAST (June 20, 2022) (CHART 4)
Oil – US Crude: Retail trader data shows 50.85% of traders are net-long with the ratio of traders long to short at 1.03 to 1. The number of traders net-long is 7.47% higher than yesterday and 27.83% higher from last week, while the number of traders net-short is 15.61% higher than yesterday and 40.80% 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.
Positioning is less net-long than yesterday but more net-long from last week. The combination of current sentiment and recent changes gives us a further mixed Oil – US Crude trading bias.
— Written by Christopher Vecchio, CFA, Senior Strategist