Commodity bear markets have a couple of common characteristics

 

 

 

 

 

 

 

  • Prices often fall further and stay weaker for a lot longer than most expect because producers tend to hang on for a lot longer than anticipated
  • Temporary bouts of optimism provide corrective rallies along the way.

 

This scenario fits the oil market at the moment. Opec has the production spigots well open and on top of this there is potential for significant supply increases from both Iran and Iraq. At the same time, the much anticipated US production cuts are yet to materialise. Last week’s data shows daily production in the US remains stubbornly high. Consequently the peak summer driving season has made only minor inroads into record inventory levels so far. The International Energy Agency calculates that world production far outpaced demand growth over the year to June, increasing by 3.1m barrels per day.

The last couple of weeks have seen an ominous build up in downward price momentum in the oil market. If this continues, the March low at around $42 in the West Texas price looks like an important line in the sand for the price charts. If it’s taken out, chart analysis suggests another leg down to mid-$30’s is a real possibility

US oil chart

The 2 charts below are monthly charts where each candle shows the open, high, low and close for a month’s trading. Large red candles signify a big trading range and a close well below the open(in other words strong downward momentum). There was plenty of this behaviour on display during the GFC and again in the 2nd half of last year (see arrow). It’s not hard to envisage, the current months’ candle as the start of a similar scenario developing.

Another feature of this chart is that the move down from the 2013 peak at $112.50 looks like an Elliot 5 wave pattern. I’ve labelled this possibility on the chart below. If this is true, the $42 low is significant. If we stay above it, then it’s possible that at least for the medium term oil will actually stage a larger correction to the upside. Something like the blue lines I’ve drawn on the chart with a rally up to the mid $60’s would fit with a typical Elliot Wave chart scenario

The worrying scenario for investors in energy stocks (and the bullish one for those own Qantas) is where the current downward momentum continues with a strong move below $42.  In this scenario, Elliot Wave analysis would suggest oil has entered the 5th and final leg down in this bearish decline.

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Under that bearish scenario, a fall to around $35 looks quite possible As the horizontal line on the chart below shows, this has been a significant level of support and resistance for oil, dating back to 2000. There are also a couple of significant Fibonacci projections around this level. Around this price the swing down from “4” to “5” would be:

 

 

 

 

 

 

 

  • 2% of the whole move down to “3” and
  • 127% of the size of the correction from “3” back up to “4”.

 

Lower prices next week and an even larger red candle for the month of July will look increasingly ominous.

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