Crude Oil Clears a Major Hurdle. Now Everything Could Change.

Posted by jbrumley on October 27, 2017 12:20 PM
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Back on October 5th we pointed out how crude oil prices were toying with a breakout move above a key technical ceiling. If cleared, a move above that resistance could serve as a catalyst that propelled crude oil to prices not expected by many to be seen anytime soon.

Crude cleared that line today, setting the stage for a rally that theoretically shouldn't be happening.

The chart below speaks for itself. After chipping away at it for several days, crude prices quietly crept above the ceiling (orange) that's tagged all the major highs going back to December of last year. Friday's jolt blasted it past the resistance line, leaving no doubt. You can also see the surge decisively cleared a horizontal resistance level (blue, dashed) that had also proven to be something of a problem.  While there are still prior peaks that could turn into new ceilings -- there always are -- this was the big one oil's bulls had to worry about.

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To fully appreciate what just happened and how game-changing it could be, however, one has to zoom out to a weekly chart of crude oil prices and recognize how long that resistance line had been holding oil back, and the context with which the thrust was made. A key technical analysis pattern underscores the bullish potential of Friday's advance.

Take a look. The ceiling that was just broken extends all the way back to mid-2015. More than that though, the three major lows seen since then make something of a head-and-shoulder pattern... just an upside down one. This shape often sets the stage for a major reversal move once the neckline is broken. In this case, the neckline is the same orange resistance line that's been holding the stock back for more than a couple of years now.

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What's interesting is how unlikely a rally seems like it should be.

Aside from the fact that the EIA is only forecasting an average price of $54 per barrel for 2018, the nation's stockpile of oil is on the rise again. Granted, it's trailing it levels lower than we've seen this time of year on recent years, but at 457.7 million barrels of stored oil as of last week, inventories are on the rise again after the impact of hurricane Harvey was put in the past.  At the same time, the U.S. dollar is on the rise, with the U.S. Dollar Index rising from a low of 94.91 in mid-September to 95.03 now (that's a lot, by currency standards). A strengthening dollar usually works against oil prices, but crude's gaining even against the headwind put in place by the rising greenback.

What gives?

In a philosophical sense,  the unlikely outcome points to just how unpredictable the market really is; things rarely behave as they're rationally supposed to. In a more tangible, actionable sense though, it's a reminder that you're better served by responding to what the market is doing rather than what it is doing.

A trend is never wrong. There's always a reason something is happening, even if it's not readily apparent. Eventually though, the rational surfaces. Waiting for it to surface, however, may mean you've waited too long to capitalize on the opportunity.

In this particular case, crude oil's rise may be a sign of what's happening out there in the real world of oil that's not yet evident in industry's metrics. The time between the point when oil is extracted from the ground and the time it's refined and put into storage ready to sell can be weeks, but that transition is hard to measure. The market can and does guesstimate that kind of information though, and it's often right. This surge in oil prices may well mean a surprising supply crunch is on the way, even if we can't see it yet.

That, or a bunch of people are very wrong.

Whatever the case, none of this is to suggest crude oil can't pull back, even if only on a short-term basis. It can, and it probably will, as profit-takers lock in some of their gains after Friday's big move. Don't overreact if that happens though. As long as crude prices remain above the ceiling-now-turned-floor at $52.40, the breakout rally is still intact and worth trading.

The next checkpoint target is the $55 area, where oil prices seemed to hit a ceiling early in this year. If that hurdle is cleared as well, there's not much else to stop it.

No, none of the forecasts have suggest oil is able to move above $54 anytime in the foreseeable future. The conviction that crude prices are going to be handcuffed, however, is in many ways a good reason to think like a contrarian and presume an unexpected move above $55 is not only possible, but likely. Remember, the people making the forecasts now were the same people that didn't see the 2014/2015 oil implosion coming.

Stranger things have happened.

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