Crude Realities

So here we are, crude oil sitting under the major $120 level. I had a discussion the other day with a person who has been bearish on crude all the way up from $70. The argument was just about the fundamentals of the market and the falling level of demand. I argued that such sometimes comes into play but for the most part, these numbers tend to lose you money trading these market - not make you money. Anyhow, the person went away all angry that I did not agree with him. My reasoning was somewhat simple: The crude market has not convincingly crushed the $120 level. If it did, then I would be calling a top but since the buyers have showed up, and the technicals overall somewhat support a move higher, I just don't think the cascade is there yet.

However, it could come to the party soon. To measure crude oil, I look at the commodities and the USO (US Oil Fund). I am not a big fan of the USO as the constant rolling of crude can distort the price action of the fund (lagging or leading it depending on the shape of the crude future curve). However the USO is useful because it provides me with a view of the retail investor's thoughts via the volume figures. Combining this together with my futures chart and economic outlook, I can reasonably come to a view on crude. So where do I think things are going from here?

Well, lets break down the parts and summarize at the end. First, the USO is telling me a few things. Money flow levels were at extreme levels around $140 a few weeks back. Generally speaking when this occurs, crude either accelerates and then levels off or it declines, like it did in late 2007. Since the extreme level, we have correct through one support area and now trying to hold a second around 95 (USO price). A break here could really open up the flood gates and set up a test much lower around $80. A break to this point though would probably flip over the power model to bearish and then my targets would be in the $50's range. So from the ETF side, crude is at support but a bounce soon will lead to another fall towards $80.

As for the futures charts, the long term monthly argues we are heading back to $110 which is somewhat opposite of the weekly which is kind of showing support at $120. Key word here is kind of though which means that if the speculation is correct in the marketplace and index funds are unloading on the market, much like they did with stocks a few months ago, there will be no bounce at $120 and $110 will become more of a certainty. A break of $110 and things get very interesting with $100 and then $80 next.

The last variable is the economy. During the previous cycles of my growth model, which measure whether we are in a bear or bull market, the crude market has leveled off during the bear side of the trade. If that is the case, then my friend, who has been wrong since $70, might actually be correct. My model turned over in November of last year. Crude was around $85/90 per barrel at that time. If the past is a guide here, crude should trade to this level and then bounce probably another 10 lower before returning to the mean, if you will.

So in summary, the USO is bearish, the futures are bearish and the bull/bear model is bearish. The average target looks to be $110 but longer term, it appears we are headed for a test with the $80 level. Further economic weakness could be a real problem though I think the dollar would weaken in such a scenario (unless the Euro falls apart) and crude will find some artificial support.