Where Did the Oil Go?
Fundamentals
Crude Oil futures are higher in overnight trading after falling for three consecutive sessions. Prices have pulled back after many market observers had begun to question whether the recent inflation concerns have been overblown. The economy is still in the early stages of an economic recovery, suggesting the price of Oil may have risen too quickly. The sharp spike in prices may inhibit economic growth and actually be a negative force for traders bullish Crude over the long term. The PPI and CPI data released this week have shown inflation being very tame, further bolstering the viewpoint that inflation fears may have been overblown.
Yesterday's EIA inventory report gave traders plenty to mull over. On the surface, the report would be seen as friendly for oil prices, but a deeper look into the numbers may tell a different story. Refinery runs were virtually unchanged after slightly higher imports for the week, yet inventories of Crude Oil dropped much more than traders had expected. This brings about the question - where did the Oil go? The data suggests that more petroleum may have been moved into floating storage. This could be a sign that some market participants may believe that the contango, which has narrowed substantially in recent weeks, may once again begin to widen. The build in gasoline inventories suggests that the petroleum market may be a bit more elastic than traders had previously thought. The build could be a sign that drivers are going to cut back usage in the face of rising prices.
Trading Ideas
Where prices go from here is up for debate. Some of the factors that have pushed prices lower for the past three sessions may be temporary, such as the stronger US dollar. Forex traders have taken profits in short USD positions, but there is little fundamental support out there for the dollar at this time. The administration has shown no signs of reining in spending, which can be seen as negative for the dollar. The lingering doubts over the economic recovery could result in less risk-taking by traders, which could adversely affect the equity and commodity markets. Current fundamentals do not support the current price levels, but, as history has shown, markets can remain irrational far longer than rational traders can remain solvent.
Technicals
Turning to the August Crude Oil chart, we see a hanging man candlestick on Friday, followed by a bearish doji on Tuesday. These candlesticks point to a negative short-term bias. The pullback, however, has failed to do any major chart damage. The August contract has maintained near-term chart and psychological support at the 70.00 mark. If this support level is broken, prices could drift into the low 60.00's. Prices could encounter significant resistance at the 76.75 level, which is the 38.2 percent Fibonacci retracement from the 147.27 high set last July. Momentum is showing a very slight bullish divergence with the RSI indicator, suggesting a possible reversal of the recent slide.
Given the overpriced conditions, traders may wish to explore entering into a bearish position. This bearish bias is driven by fundamentals and is not supported by technicals. For those wishing to be short Oil, Tthe high volatility of the futures contract and expensive option premiums may could potentially make entering a bear put spread a prudent strategy for those wishing to be short Oil. Bearish traders may wish tcould potentially o purchase an August 67.50 (CLQ967.5P) put and sell an August 65.00 (CLQ965P) put for a premium of 0.60. The initial investment of $600 is risked and the maximum profit is $1,900 if the August futures contract closes below 65.00 on the July 16th expiration date.
Rob Kurzatkowski, Senior Commodity Analyst
