Are hedge funds right to be bullish on oil?
From the Financial Times on Monday:
Hedge funds have amassed the biggest ever bet on rising oil prices as investors back Opec’s bid to tighten the crude market and seek protection against fears of inflation.
Data from regulators and exchanges showed speculators have built long positions equivalent to almost 1bn barrels of crude across the major contracts, while short positions amount to just 111m barrels.
This one-sided bet has left speculative investors holding a record net long position — the difference between bets on rising and falling prices — in Brent crude and West Texas Intermediate futures and options contracts equivalent to 885m barrels by January 31.
Let’s have a look at the bullish argument by starting with the weekly chart.
One could argue that we have a bullish inverse head-and-shoulders pattern with the neckline drawn. You can see this in the chart above. However, the fact that the price has only traded sideways since breaking above the neckline in early December makes me suspicious. This pattern may not play out as the theory would suggest.
If the price does start to move higher, at least beating the January high of $55.24, we could push on to the first Fibonacci target of $59/$59.10. The 2015 high for WTI crude is $62.58 and obviously this will need to be broken for more significant gains targeting $63.70. Then we would target the 200-week moving average and the 50% Fibonacci at $68.50/$69.20.
Bear in mind, however, the measured target for the inverse head-and-shoulders pattern is around $75. If you look at the weekly chart again you’ll see the green 500-week moving average intersecting exactly on the 61.8% Fibonacci target and resistance at $79.20/$79.40.
In theory, therefore, we could reach as far as this important level over the course of this year.
The contrarian inside me, however, makes me far more wary of a rush to the exit and a significant move to the downside. This is because the price has not moved higher on such heavy recent buying.
Prices had been heading higher since a bottoming out in mid-November. They reached a peak of $55.24 on the first trading day of this year. Since then, however, we’ve been trading in a relatively narrow range down to a low of $50.71 made in the second week of January. In the last four weeks we’ve been unable to move out of this $4.50 range despite heavy buying from funds.
What are the risks to the downside?
As you can see in the four-hour chart below, we have been in a rising wedge pattern over the past three weeks. We are testing the lower trendline of that pattern as I write. We have good support here also from the 100 and 200-period moving averages. So far this important support level at $53/$52.90 has held perfectly.
This could therefore trigger a move in the very short term towards the upper trendline of the rising wedge in the $54.60/$54.80 area. However, a break below the short-term Fibonacci support at $52.78 would be confirmation of a break of that important support area at $53/$52.90. This would be a short-term sell signal.
A break of last week’s low at $52.24 is also a break of the inverse head-and-shoulders neckline I pointed out on the weekly chart above. This is therefore further bearish confirmation, targeting $51.30/$51.20 before a test of the January low at $50.90/$50.70.
A break of the January low has us testing the 100-day moving average at $49.90/$49.70. I’m guessing investors and funds who have been buying in the low-$50 region will be considering easing up on long positions if we start to close a few days below this area.
Technical Analyst & Trader
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