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Can Crude Snap Out of Bear Market?

Monday, October 3, 2011

Crude Oil finds itself mired in a bear market, after closing more than 20% off of late April/early May highs. Traders have had little positive economic news to latch onto, especially in housing and employment. This paints a negative demand outlook. Couple this with lower growth forecasts for China, and it is not difficult to see why bulls have left the market. Technically, Crude Oil is in a textbook bear market, but there has not yet been a convincing downward breakout from the 2-month old trading range in which the market finds itself. The possibility of a downside breakout is probably more likely than a reversal at this point. Some traders may possibly wish to consider testing the bearish side of the market with a bear put spread. With implied volatility at high levels, vertical spreads are less costly than they historically have been. An example of such a spread could involve buying the November Crude Oil 80 put and selling the November 75 put, for a debit of 1.25, or $1,250. The trade risks the initial cost and has a maximum profit of $3,750 if the November futures settle below 75.00 at expiration.

Fundamentals

Crude Oil futures remain mired in a slump, unable to gain any sort of traction due to a weak economic outlook. The US supply remains more than adequate at the moment, so many traders may shift their focus to economic data. This week is heavy with employment data, with the ADP Employment Change and Non-Farm Payroll data joining the weekly claims data. Funds have slashed their net long position by over 14,000 contracts, while some smaller specs have cut their net position by over 4,000 contracts. There is little chance of funds or specs changing their net positions ahead of the employment data. Many traders will likely also be focused on the EU meetings in Luxembourg , where the pan-European union will discuss the almost inevitable Greek default. Many speculators spear to have soured on Crude Oil, for the most part, and some net long holders of equities have also shorted the contract as a macro hedge. For Oil traders to regain the zeal seen earlier this year, there likely needs to be a sharp turnaround in economic sentiment.

Technical Notes

Turning to the November Crude Oil chart, we see prices lingering just below the 80.00 level. Thus far, the bears have not been able to push prices convincingly lower to signal a downside breakout from the 80-90 trading range. The recent failure to test the upper end of the trading range could be seen as a negative sign. The RSI is near oversold levels, which can be seen as somewhat supportive of prices in the near-term.

Rob Kurzatkowski, Senior Commodity Analyst