WTI crude technical analysis: how will prices react to tomorrows EIA inventories report?

Tonight’s industry-backed API crude inventory report showed US domestic crude stocks increased a staggering 8.97 million barrels, way above the estimate of a 0.5 million rise predicted by a Bloomberg survey.  Following the announcement, WTI prices declined by approximately $0.5, although had risen by nearly $0.8 in the two hours before the announcement. With tomorrow’s EIA report likely to show a similar rise in stocks, and markets trading down today due to the Bank of Japan refraining from adding additional stimulus, do the technical support the view that crude could fall further?

On the daily chart below we have three indicators shown; Bollinger bands, the MACD and the William %R. At the moment neither the MACD or William %R have cross into selling territory, as we would expect the green MACD line to cross the red signal line or the zero line and the W%R to cross below -50. As we can see from the latest candlestick on the daily chart, the reason for these both remaining some strength is that the WTI crude price rebounded from its earlier low of $94 to its current level of $94.86. Given the rebound happened before the much higher than expected rise in inventories, we can gather some clues from the higher frequency charts as to whether the price may decline further tomorrow.

On the 30-minute chart below, the same three indicators show that crude is also testing its 30 minute middle-Bollinger band (the 20-day MA), the MACD lines are in a similar place to the daily chart and while the W%R has already crossed below the -50 mark.

With both charts testing typical support areas, the MACDs approaching a potential cross-over selling signal and the W%R of the higher frequency already giving a sell signal, signs are strong that WTI has the potential to carry on falling further if economic sentiment remains bearish tomorrow. However, traders looking to go short should wait until a full set of signals are received. On the higher frequency charts, resistance areas can be seen at around $94.5-94.4. If this boundary is breached, we should expect to see WTI fall to the $94 boundary, which marks both the 20 and 200 day MA. 

WTI Crude Technical Analysis: Further to fall?

WTI has trended downward from a high of $96.8 on 20^th May to reach as low as $91.20 at the start of the week, before rebounding back up to where it currently sits at $93.8. While the grade saw some strength in the last couple of days, the question we need to answer is whether this is a rebound from technical resistance that will result in an upward trend, or whether the grade is destined to fall further over the coming days. To answer this question, let’s look at some of the technical indicators.

Firstly, two oscillating indicators, the MACD and Williams %R both give slightly bearish signals on the daily chart. In terms of the MACD as shown below, there was a signal crossover back at the fall from the peak price on the 21^st, while a zero-line downward cross was seen at the middle of last week. Both predicted the trend over the following days well, and both remain in bearish territory, albeit with the MACD showing some sign that it could cross the signal line if positive momentum continues.

The Williams %R below shows similar signs, with the indicator having made a bearish cross back on the 22^nd May when it fell below the -50 mark, before falling deep into oversold territory on Friday 31^st May. Such oversold signs could go to explain the current rebound, in which the indicator is yet to test either the -50 mark or the overbought area at -20 and above and hence remains somewhat inconclusive.

Importantly though, Bollinger band patterns appear to be showing an “M top” pattern, in which the WTI grade failed to reach the upper Bollinger band on either of its last two high-points, with the second point diverging further than the first. This was followed by a strong cross of the middle-band and the crossing of previous support, with the grade settling below its lower band on two occasions in the last four sessions, showing the strength of the bearish momentum and suggesting that the latest rebound could be a slight correction on a downward trend rather than the reversal of that trend.

Trade Recommendation

With tomorrow the day for the weekly EIA report, the results will be the perfect opportunity for bears to grapple with the bulls and determine whether this downward trend for WTI will continue. I believe such an outcome is likely, and unless WTI shows signs of breaking above the $94, or if the grade does break above but then falls back strongly, then I suggest selling WTI with a target of  $92-$91.5. 

Brent and WTI technical analysis: Waiting for a trend form?

As the charts below shows, Brent and WTI have both been trading in a range since the beginning of May, with the North Sea grade ranging between $101-$105 and the US grade trading between $92 and $97.

A variety of factors have contributed to the sideways motion, but above all markets are locked in a battle of sentiment, with negative economic news one day balancing out against positive signs the other. Importantly however, technical analysis shows that if we are about to embark on another trend, then we could be looking at a strong bullish one.

The reason for this is that the lower Bollinger band has combined with the lower support area to form a very strong area of support that could form the lowest point of the next upward trend. What’s more, today both WTI and Brent dropped below these respective areas but climbed straight back up, unable to closer below them, thereby confirming the support areas as the charts below show.

It could be a few days before we confirm a possible upward trend, but the moving average indicators could be the key to demonstrating the upward move. At the moment on both the Brent and WTI charts above we see that the 10-day moving average (MA) has been mostly steady over the last week, with the 5-day oscillating above and below, confirming the range-trending scenario. Thus if we’re to see Brent and WTI break out into an upward trend then the first key signs will be for the 5-day to maintain its current position above the 10-day MA, and for the 10-day MA to lift itself away from its current position on both graphs, that is above and beyond the 20-day (the middle Bollinger band).  

The Correlation between Oil and Other Market Products: Equities

Many traders look for correlation strategies where either a trend in some security translates into a trend in another, or the disconnection of trends between two normally correlated securities results in a potential trade opportunity as the prices re-converge. Much of the most popular information out there at the moment is on currency correlations, but possible trade ideas are not just confined to products within the same asset class. Indeed, in the first of a series of posts looking at how oil trades in relation to other products, I’ll be taking a general look at the relationship between oil and equities.

To begin with, a quick overview of the causes of oil price changes is necessary to give some context to the changing relationship between oil and equities. On a fundamental level, there are four possible causes of oil price changes stemming from changing supply and demand, with the effect on equities outlined on the table below:

Increasing oil prices can be caused by either higher demand or lower supply and the cause behind the oil price change will determine the effect on equities and thus the correlation between the two. In the case of higher demand the cause behind the rise in prices is higher spending across the economy, thus increasing corporate profits as well. In the case lower supply, higher costs to consumer’s fuel bills will likely reduce disposable income and thus cause corporate profits to fall. On the other hand lower oil prices could be caused by either lower demand, and thus lower spending and lower corporate profits, or higher supply and thus lower costs and higher corporate profits. Obviously these are general cases which have their own contradictions in the long-term, such as increasing fuel efficiency decreasing oil demand while increasing disposable income, but such examples tend not to distort short-term correlations.

To demonstrate the changing relationship between oil and equities over 2013, the two charts below show week on week price changes of the S&P 500 US equities index and Brent as well as the 10 day correlation between the two price levels. In the first marked section from mid-January to the beginning of March, Brent and the S&P 500 mostly moved in tandem with each other. For a period during March however, the two moved away from each other as the S&P 500 increased while oil prices fell. Followers of markets will remember that the first time period was characterised by increasing economic confidence to begin with, which led to higher demand expectations for both equities and oil, but was then followed by economic news failing to meet expectations as both prices fell. In early March however both demand forecast cuts by international agencies and further problems in the euro area cut expected global oil demand and thus prices for Brent, while US equities continued to advance as conditions there were generally positive.

How to profit from the correlation

While many other factors come into play, particularly in today’s climate of quantitative easing, the correlation between US equities and oil begins to show the potential of correlation strategies in creating profitable trades. Take the point marked A on the graph below as an example, oil and equity had been highly correlated on economic confidence, but some worse than expected economic data releases resulted in falling US equities and oil prices. In this case shorting both on those announcements would have been profitable strategy. 

Next week this series of posts will take a look at how oil prices are correlated with currencies, so check back soon.

Weekly Crude and WTI Oil Market Summary: Brent falls below $100 for first time in 9 months.

15/Apr/13 - 19/Apr/13

In the week preceding this, announcements form major international energy organisations adjusting oil demand forecasts downward caused a massive sell-off of the energy commodity, and the trend continued this week as economic data continued to cause prices falls in WTI and Brent. Brent lost -3.3% and WTI -3.6%, with Brent maintaining its premium as the spread closed yesterday at $11.6, the same level it opened at on Monday. Notably Brent closed below $100 on Tuesday for the first time since July, but failed to maintain a rebound above $100 on Friday.

Weekly Summary

Weak economic data showing Chinese GDP growth failed to meet expectations caused plunging Brent and WTI prices on Monday, with the grade failing to rally in European afternoon trading as US data confirmed economic weakness there as well. Due to the Chinese data, Brent opened in European trading $0.4 below its previous close, and then continued to lose -1.9% in trading. WTI meanwhile gapped down a similar amount but fell a larger -2.5% in trading. Further demand forecasts were cut by the World Bank, which reduced its growth forecasts for East Asia and warned of potential overheating, which would require central banks to raise interest rates. While the sell-off caused Brent to fall to its lowest close since August 2012, markets were more focussed on Gold which lost a massive 10% in one day of trading. The fall was caused by a bearish reaction to signs that indebted governments, such as Cyprus, may have forced to sell hard gold assets in exchange for financial bail-outs.

Crude continued to fall overnight in Asian trading, and Brent lost $1.7 from its Monday close to open in Europe at $99, similar to WTI which lost $1.3 overnight. While the grades rebounded in European trading, with Brent gaining 1% and WTI 1.5%, the earlier falls meant that Brent fell below $100 for the first time in 9 months. The European within-day rebound was similarly seen in other commodity markets, which may have been caused by a fall in the USD and a feeling that the previous drop was too much too soon, prompting some buyers to take advantage of the lower prices.

Such a move was ill-conceived however, and crude plummeted again on Wednesday in a reaction to the weekly EIA release showing increasing production and falling demand. For more details on the release, see my weekly inventory post. Bearish sentiment also entered the market as US corporate earnings came in at disappointing levels, and the USD strengthened from its previous fall, gaining 1.3% versus the euro. The bearish report and negative correlations with such currency gains caused Brent to fall -2.3% and WTI -2.4% on the day.

WTI and Brent had both closed below their lower Bollinger band on Wednesday, which as the graph shows in previous sessions had caused a next-day rebound which was demonstrated again on Thursday, prompted by further technical support from the RSI being below the 30-mark (see my previous technical trading post for more on the RSI). Such signs typically see buyers enter, even if for short-term profits. Signs of longer-term profits were also seen as the long bearish run raised the expectation that OPEC may begin to feel an output cut is necessary. Venezuela is particular announced concerns on Thursday, and with the country under political turmoil following a disputed election, there is a strong incentive for the government to secure higher oil prices and thus budget revenues. Despite the next OPEC meeting not being scheduled until 31^st May, prices could rise in the interim as Shell declared force majeure on its Nigerian Light Bonny crude for pipeline repairs and data shows seaborne exports from OPEC will fall in the four weeks to May 4. Rises in Brent and WTI could have been higher were it not for economic activity indicators out of the US coming in negative.

Reports that an ad-hoc OPEC meeting could be held boosted Brent on Friday, but apart from that a lack of notable data traders had a comparatively quiet day, with WTI falling a -0.4% and Brent up 0.2%. By the afternoon, OPEC had denied the announcement and Capital Economics pointed out most OPEC nations are comparatively healthy after recent high oil prices, and so urgency may not be on the cards. PVM, an oil-broker, suggested that the week-end rally is likely to have been caused by a closing of short positions before the weekend and for profit-taking at the $100 mark, resulting in the North Sea blend dropping back to close at $99.65.

Week Ahead

Next week will be quite data-heavy, with a number of global data releases being released. In the US,  everyday next week promises a release that normally moves markets, with home data on Monday and Tuesday, goods orders on Wednesday, the regular weekly jobs update on Thursday and a first-release of Q1 GDP data on Friday. China will see its monthly PMI first release early on Tuesday, which will be of particular note as the indicator has a high correlation with GDP, therefore giving an indication of how Q2 GDP could develop. The euro area first-estimate PMI will also be released after China’s, which could bring the euro zone back into focus again, particularly with investors waiting to see whether the ECB will engage in full-blown QE. This will be followed by the German IFO on Wednesday, which gives an indication of business confidence the euro area’s largest economy. On Thursday UK GDP data will be releases.

On a technical view, investors will be waiting to see whether the current situation is a temporary retracement on a continuing bearish run, or whether we have now hit the bottom and be aligned with fundamentals. Some analysts say $85 would be an appropriate price for WTI, while OPEC in particular may not be happy with less than $100 for Brent. Given current fundamental infrastructure issues between the two grades ( see “On a path to convergence”) mean a spread of closer to $10 than $15 is appropriate, we’ll have to wait and see to find out which grades gives in. For more detailed technical analysis, look out for tomorrow’s week-beginning technical update.

Weekly WTI Crude Oil Inventory Analysis: EIA release of 17th April

Summary of today’s release: last weeks’ change in Crude Inventories figures:

API: -6.7m

EIA Consensus:  +1.2m

EIA actual: -1.2m

Crude continued its bearish run today, with both grades dropping by more than 2% in the face on an EIA report that continued to remind traders of the fragile demand and supply situation in the US. While overall crude stocks dropped, the cause of this fall seemed to be a reduction in imports rather than an improving US demand situation. Indeed, the detail showed that US domestic production had increased while refinery input decreased. These factors, combined with a large stock-build at Cushing and a fall in distillate and gasoline products supplied to consumers, reinforced the current bearish outlook.

Detailed Breakdown

US domestic crude production climbed 27,000 barrels to reach 7.2mb/d last week, while net refinery input dropped by 40,000 b/d. The fall in refinery input only represents a 4% drop in the gains seen over the preceding 4 weeks, and could be a result of the continued softness of crude product demand in the shoulder period between winter fuel and summer gasoline peak demand. Such a demand situation was confirmed in this release, with gasoline product supplied falling by 94k/d and distillate fuel by -226k/d.

The bearish reaction to the drop in stocks may also have been caused by details in the regional breakdown. Despite the -1.2mb fall, the region that caused this decline was the demand heavy West Coast, where stocks fell by -1.8mb. Meanwhile, there was a 1mb rise at Cushing, with stocks there reaching the highest point since January. With a lot of traders focussed on transportation bottlenecks, such a sign is worrying as it implies crude might be finding its way to Cushing but not onward to the Gulf Coast. Such an idea may have been affected by the recent completion of the line-fill of the Longhorn pipeline, which was completed last week. This process was taking up some crude from the system, but actual deliveries are not expected until this week, and so this could have caused the temporary build-up (For more on that see my previous post Seaway No Solution).

How Markets Reacted

Brent has been on a bearish run since 2^nd April, when the grade reached $111.8 before dropping by $14.1 to end today at $97.7. WTI began its bearish run a few days earlier, falling from $97.7 to reach just under $87 today. Clearly there is a bearish sentiment in the market, and as in other weeks we’ve seen market reacting positively despite a negative headline number, this week we see markets reacting negatively despite a positive headline number.

As the chart shows, the Brent price initially ticked up slightly at 14:30 GMT after the release, but soon dropped by about $0.90 as analysts saw the details and continued to drop by a further $0.5 before rebounding slightly after the European closed. WTI followed a similar pattern, and both grades dropped on the day.

Outlook: How Low Will It Go?

US production reaching a 20-year high was hailed as a major headline by some news outlets, but in reality we already saw that headline a few weeks ago, and will likely continue to see it this year. As regular followers of the EIA report will know, the details can be overshadowed by the current market sentiment, with what we’ve seen over the past two weeks of a bearish market possibly being a correction to the previous weeks in which crude has increased endlessly despite bearish details and a loose market. Hence it’s difficult to predict next week’s release, but crude will likely rebound at some point, albeit perhaps temporarily.

In particular, technical indicators such as the RSI show that WTI could be due a rebound before the end of this week. As the day-chart below shows, WTI has reached a new low while the RSI has failed to reach a lower low than the one two days ago. This is known as an RSI bullish divergence, as detailed in my previous post of technical trading strategies.

Crude Oil Technical Strategy: Trading the Relative Strength Index (RSI)

Read oil market news and you're bound to come across references to technical analysis, which is viewed by many traders as an important tool in predicting price changes and signalling market momentum. While most will say that technical analysis should be used as a confirmation of fundamental views, there are many traders who claim to have successfully implemented trading strategies based solely on quantitative and technical analysis. In the first of a series of posts, I'll be looking at whether a simple momentum indicator can be used to create a profitable oil trading strategy.

The first indicator we’ll look at is the Relative Strength Index (RSI). The RSI is a momentum oscillator; it cycles between a value of 1 and 100 and measures the trading-momentum of a security.  A higher measure indicates a security could be overbought and a lower number oversold. (For more on the calculation of the RSI, check out this article at Investopedia.) A rough guide is that anything over 70 represents the security being overbought, and anything below 30 represents oversold. A potential strategy therefore can be to go short when the reading is over 70 and go long when its below 30. While there are plenty of articles out there discussing the strategy for stocks and currencies, how does the strategy play out for crude?

To take a first-look at the strategy, I’ve downloaded a price-set from EIA and created a 14-day RSI for the beginning of 1986 to the beginning of 2013. Using a VBA-script, the file loops through the data and works out the return from a buy and sell strategy in which the upper and lower RSI limits vary, thereby allowing for values of the upper and lower bounds to vary around the 30 and 70 marks. 

The table below shows the results. The non-strategy return, that is buying crude on day 1 and selling on the last day, results in a return of 389%; an equivalent annual rate of 6.1%. As the highlighted cells show, the best strategies are located around the (30-40, 76) limits or the (40-44, 60-64) limits, with the two best results being (44, 62) and (40, 76).

When using the (40,76) options for the lower and upper limit, there are only 88 days when the RSI is over 76 but 1208 when it is below 40, out of a total 6828 days in the data set; thus the strategy is almost entirely just predicting a few key selling points. In contrast, the (44, 62) presents a more-even strategy as there are 1829 buys and 1259 sells. (44, 62) however is a long way from the orthodox 30 and 70 mark; so is RSI really applicable in this case, or are we just getting lucky?

The truth is, the RSI alone is probably not going to give us a profitable trading strategy. As OptionAlpha points out, a more powerful indicator can actually be an RSI divergence. This is when the price reaches a higher high (lower low) but the RSI fails to reaches below its previous high (low). Graphically we mean something like below (taken from OptionALpha). This could explain why less extreme RSI thresholds are actually giving a better return. Alternatively, it may be we need to combine the RSI with another indicator to give a better indication of possible trends. In fact it’s common to use the RSI with a moving-average indicator; something we'll look at in more detail in the next post in this series.