Crude Oil: The End of the Rally Is Near March 10, 2011

A couple of weeks ago, we talked about the troubles with civil uprisings in the Arab League that are toppling dictatorships.

Fear of a major disruption in oil production, along with an actual loss of about one percent of the world’s oil supply, has caused crude oil prices to skyrocket. This significant rise in the cost of crude has impacted the price we pay for many things including a gallon of gas and the valuation of the stock market in general.

However, there are technical, fundamental and geopolitical reasons to believe that at least a short term top in crude is near. Let’s look at crude from both perspectives.

Fundamentals of Crude: Supply and Demand plus Geopolitics

The geopolitical angle of this game is fairly easy to see, for a change. The worries about disruption in oil supply due to the Arab League turmoil have largely been baked into prices already. Remember the old trader’s adage, “Buy the rumor, sell the news.” The Libyan civil war is largely at a standoff. So the news event that could reverse the meteoric rise in crude could come Friday in Saudi Arabia’s “Day of Rage.”

Many informed pundits predict that the pre-planned protests in Saudi Arabia will be a non-event. The Saudi government is much more mature and stable than those of Tunisia, Egypt or Libya. And the National Guard there is very loyal to the royal family. Lastly, Saudi’s great wealth has been spread around fairly well, giving less cause for true economic outrage.

On the supply and demand front, there has been no news that could contribute to the 22%+ rise in crude oil prices. In fact, a glut from Canada has caused the U.S. reserves to be filled to the brim. And even though the Arab League problems have caused a 1% disruption in daily oil flow, the Saudis have stated publicly that they stand ready to increase supplies to cover this shortfall if needed. The US has also hinted that it could dip into the strategic reserve.

The Technicals in Crude Are Ready for a Retrace

A quick look at a crude oil price chart will show that this big run-up in crude oil has overstretched price to the upside.

As we can see in this chart, the RSI reading has only topped 70 (the traditional level for an oversold reading on this indicator) for crude oil twice in the last 15 months (before the current run). Both instances were met with pullbacks. Obviously, this run-up was more severe than the other two, which only had one day each above the 70 level; the current run has spent 6 days above that level.

The RSI reading alone doesn’t mean that a crude pullback is eminent, but if the Saudi rallies on Friday are uneventful, that could relieve some of the political tension that is holding crude prices high in the face of plentiful supply. A pullback to the 50% retracement of this run-up would then be very likely.

I’d love to hear your thoughts and feedback on this article or about trading and investing in general at drbarton “at” iitm.com. Until next week…

Great Trading,
D. R.