Crude oil's uptrend faces challenge

By George Albert

The long term uptrend in crude oil that began in February 2009 is facing a serious challenge in the near future as the US Dollar rallies and fear of a slowdown hit global markets.

After the drastic fall in crude oil prices from $190 per barrel in July 2008 to $60 per barrel in February 2009, the commodity has been slowly rising to touch a high of $115 in may 2011. The rise has been largely due to the increased demand from Asia and the deflating dollar. In early 2009, the Federal Reserve Bank began its quantitative easing, which is slated to end in June. As the Federal Reserve began pumping more money into the system the value of the US Dollar fell.

[caption id=“attachment_27952” align=“alignleft” width=“380” caption=“Until prices fall below the $90 level, the current drop in crude can be considered a buying opportunity.Mark Ralston/AFP Photo”]  [/caption]

Since majority of the oil trade is invoiced in the US, a drop in the value of the greenback leads to a rise in the price of oil. The combination of increased oil demand and falling dollar led to the steady rise in the price of crude. A look at the chart below will show that crude oil has been moving in an up-sloping channel. Every time, crude oil touched the upper end of the channel, it sold off, and rallied when it reached the lower end of the channel.

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Now with the fear of a global market slowdown, the price of crude is falling drastically and the dollar is rallying as investors seek a safe haven. Additionally, the stopping of the quantitative easing programme is putting a downward pressure on oil. As of last week, the uptrend in oil was still intact but is likely to face challenges in the coming weeks. If oil continues lower and closes below $90 per barrel next week or after that, the uptrend channel would be broken. A break of the channel will be bearish for the commodity and prices can continue lower.

However, until prices fall below the $90 level, the current drop in crude can be considered a buying opportunity. Crude closed at the $93 level last Friday and we’d wait for prices to come down the the $90 level before buying. Since the upward channel has held for such a long time, it’s likely that prices will hold this time too. In case the channel does not hold, one could always get out of the oil position. Like they say in the market, buy low and sell high. But very few people do that, as there is panic when prices are falling. It is important to remember that the risk of a loss when buying at $90 and getting out at a loss at $89 is much lower than buying when prices are at say $95.

Traders and investors planning to take positions in oil must also look at price action of the dollar and the stock markets. Last week we had mentioned that the S&P 500 is near a zone from where it could rally. The zone was 1236-1247 on the S&P 500 futures contract. Last week, prices came down to 1252 and rose. Unless prices break below the 1236-1247 zone it’s too early to get bearish on the stock markets as well as crude oil. Remember that the Indian equity markets too could get a bounce if the S&P 500 bounces.

Dollar is the other asset class that investors need to look at before taking a position on oil. Last week the dollar index, which measures the greenback against six major currencies, reached the 76.50 level and sold off. Unless the dollar rallies to close above 77, we may not see crude oil break its upward channel.

George Albert is based in Chicago and edits www.capturetrends.com