Back into Dynamic Support/Resistance Zone – What’s Next?

Crude Oil Outlook:

• The crude oil price rally is facing its first challenge as it returns to a dynamic support/resistance zone in play since February.
• The downtrend from the June and August swing highs has broken, and technical momentum has accelerated in recent days.
• According to the IG Client Sentiment Index, crude oil prices have a mixed bias in the near-term.

First Down Day in October

Crude oil prices have had a strong start to October and 4Q’22, trading higher every day thus far up until today. The brief reprieve in bullish momentum comes in the wake of the September US jobs report on Friday, which has sparked a rise in US Treasury yields amid speculation that the Federal Reserve is not close to ending its rate hike cycle any time soon.

In turn, growth expectations for both the US and global economies are deteriorated, weighing on energy markets. Activity in options markets shows that traders are using the rally to put on hedges, with higher put volumes than call volumes in recent days.

Regardless, with global recession fears discounted – from a US recession to China’s unending zero-COVID strategy – focus in the near-term remains on the supply-demand imbalance in the wake of the OPEC+ decision to cut production by 2 million barrels per day. Deteriorating supply ahead of the winter months in the northern hemisphere, especially as Europe stares down an energy crisis, are likely to provide a meaningful cushion under crude oil prices for the foreseeable future.

Oil Volatility, Oil Price Correlation Remains Negative

Crude oil prices have a relationship with volatility like most other asset classes, especially those that have real economic uses – other energy assets, soft and hard metals, for example. Similar to how bonds and stocks don’t like increased volatility – signaling greater uncertainty around cash flows, dividends, coupon payments, etc. – crude oil tends to suffer during periods of higher volatility. Crude oil volatility dropping back has provedsupportive of the recent rise in crude oil prices.

OVX (Oil Volatility) Technical Analysis: Daily Price Chart (October 2021 to October 2022) (Chart 1)

Oil volatility (as measured by the Cboe’s gold volatility ETF, OVX, which tracks the 1-month implied volatility of oil as derived from the USO option chain) was trading at 52.06 at the time this report was written. The 5-day correlation between OVX and crude oil prices is -0.71 while the 20-day correlation is -0.25. One week ago, on October 3, the 5-day correlation was -0.02 and the 20-day correlation was -0.79.

Crude Oil Price Technical Analysis: Daily Chart (October 2021 to October 2022) (Chart 2)

Crude oil prices have broken the downtrend from the June and August swing highs in recent days, returning back to the dynamic support/resistance zone between 90 and 93 since February. Momentum has turned bullish over the past week. Crude oil prices are trading above their daily 5-, 8-, 13-, and 21-EMA envelope, which is in bullish sequential order. Daily MACD is trending higher through its signal line, while daily Slow Stochastics are now in overbought territory. For the time being, a ‘buy the dip’ approach is appropriate; near-term resistance comes into play at the August swing high at 97.66.

Crude Oil Price Technical Analysis: Weekly Chart (March 2008 to October 2022) (Chart 3)

Bearish momentum has eased on the weekly timeframe. Crude oil prices above their weekly 4- and 13-EMAs, and are working on their first close above their weekly 26-EMA for the first time since the week of July 5. Weekly MACD is starting to turn higher but remains below its signal line, while weekly Slow Stochastics have exited oversold territory. A weekly close above the weekly 26-EMA at 93.39 would help reinforce the bullish technical reversal narrative.

IG CLIENT SENTIMENT INDEX: CRUDE OIL PRICE FORECAST (October 10, 2022) (CHART 4)

Oil – US Crude: Retail trader data shows 49.82% of traders are net-long with the ratio of traders short to long at 1.01 to 1. The number of traders net-long is 9.64% higher than yesterday and 15.89% lower from last week, while the number of traders net-short is 1.05% higher than yesterday and 42.75% higher from last week.

We typically take a contrarian view to crowd sentiment, and the fact traders are net-short suggests Oil – US Crude prices may continue to rise.

Positioning is less net-short than yesterday but more net-short from last week. The combination of current sentiment and recent changes gives us a further mixed Oil – US Crude trading bias.

— Written by Christopher Vecchio, CFA, Senior Strategist