September 26, 2018 - 9:30 AM EDT
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Crude Oil and Its Another Interesting Relationship

Tuesday's unsuccessful attempt to break above upper borders of the rising trend channels cost oil bulls more than many buyers expected. Their weakness was quickly detected by the rivals, who took control during yesterday's session. The effects of their attack are seen not only on the crude oil charts, because they also affected the interpretation of our next interesting ratio. Is it possible that the relationship between black gold and the general stock market will give us valuable tips on the future of light crude as it has many times in the past?

Let’s take a closer look at the charts below (charts courtesy of http://stockcharts.com).

Technical Picture of Crude Oil

Light Crude Oil - Continuous Contract Daily

In our yesterday’s Oil Trading Alert, we wrote that although the price of crude oil broke above the upper line of the blue rising trend channel and the red dashed resistance line (the upper line of the red dashed trend channel based on daily openings), not everything went as well as the bulls planned.

The buyers’ weakness just after the breakout encouraged oil bears to act, which resulted in a pullback that took the commodity below both previously-broken lines. Thanks to this invalidation of the breakout, market participants created a quite big doji candlestick, which emphasizes the investors' indecision about the direction of another move.

Although oil bulls showed strength in previous days, the candles they created in the previous week from day to day were getting smaller, which in combination with the falling volume (we wrote more about this issue in our last week’s alerts) suggested that the rally was running out of steam.

Additionally, the RSI climbed above the level of 70 (we didn’t see such high reading of the indicator since late January), the CCI deepened the bearish divergence, while the Stochastic Oscillator generated a shy sale signal. All the above-mentioned arguments, increase the probability that further deterioration is just around the corner.

From today’s point of view, we see that the situation developed in line with the above scenario and crude oil moved quite sharply lower during yesterday’s session. Thanks to the oil bears’ attack, the price of the commodity only re-tested the strength of the upper borders of the mentioned rising trend channels, but then reversed and declined.

As a result, black gold also slipped under the previously-broken upper line of the red rising trend channel (based on intraday highs and lows), invalidating the earlier breakout. It is worth emphasizing here that we could observe similar price action in May.

Similarity to May

Back then, crude oil extended losses very quickly as oil bears showed their strength on the following days. The consequence of their pro-decline activity was a downward move, which took the price of light crude not only below the barrier of $70, but also erased most of the April-May increases.

Will history repeat itself once again? In our opinion, it is very likely, and we have 7 important arguments that support the pro-bearish scenario.

The Reasons

First, the mentioned invalidations of the breakouts above the upper borders of 3 rising trend channels.

Second, higher volume during yesterday’s session (compared with what we saw during recent upswings), which significantly increases the likelihood that the bears are starting to get stronger.

Third, the RSI joined the Stochastic Oscillator and also generated a sell signal.

Fourth, the overall long-term situation (we wrote more about this issue on July 2, 2018).

Light Crude Oil - Continuous Contract Monthly

As you see on the above chart, the proximity to the next resistance zone (created by the August 2011, October 2011 and June 2012 lows), which begins at the level of $75.71 (only 44 cents above this month’s peak) also favors oil bears and their plans.

Fifth, the relationship between the black gold and the S&P 500 described below.

Relationship Between Crude Oil and General Stock Market

Light Crude Oil - Continuous Contract Weekly/ S&P 500 Large Cap Index

The first thing that catches the eye on the above chart is another unsuccessful attempt to go above the upper border of the green rising trend channel. As you see, although the buyers pushed the ratio sharply higher in the previous weeks, this major resistance line stopped them – similarly to what we saw 12 times in the past!

From this perspective, we additionally see that despite breakouts in February, March and at the end of April, the ratio didn’t manage to move higher, which translated into declines in the following week(s).

What’s even more interesting, the bulls fought fiercely with this resistance for just over a month (between mid-April and the last candle closing the week of May 21), but all their efforts ended in failure. As a result, the value of the ratio dropped sharply, reaching the lower border of the green rising trend channel in the following weeks.

What does it mean for the price of crude oil?

Taking into account a very strong positive correlation between light crude and the ratio (please note that it is even stronger than in the previous months), we believe that another decline in the ratio will be reflected by a fall in oil prices.

Are there any technical factors suggesting declines in the ratio? Oh yes, they are. Let’s take a look at the short-term chart below.

Light Crude Oil - Continuous Contract Daily/ S&P 500 Large Cap Index

Looking at the daily chart, we see that the ratio invalidated the earlier breakout above the upper border of the red rising trend channel, which doesn’t bode well for the bulls. Additionally, all daily indicators generated sell signals, giving the sellers even more reasons to act.

At this point, it is worth noting that over the last year, the RSI generated the sell signals (except yesterday) only 3 times. What happened in the following days? In all cases, we could observe smaller or larger drops, which significantly increases the probability of further deterioration in the ratio and also in the case of crude oil – especially when we factor in the fact that the correlation between the price of the commodity and the value of the ratio is even higher on a daily basis than on a weekly basis.

And speaking about crude oil relationships…. the sixth reason for further declines is the correlation between light crude and the oil-to-gold ratio.

Crude Oil – Precious Metals Link

Light Crude Oil - Continuous Contract Monthly/ Gold - Continuous Contract

On Monday, we wrote the following:

(…) the ratio approached the 61.8% Fibonacci retracement based on the entire 2013-2016 downward move, which suggests that even if the ratio moves slightly higher, the space for gains may be limited by this important resistance in the very near future.

Additionally, the RSI climbed to its highest level since 2013 (…) such high reading of the indicator (we marked it with the red ellipse) preceded a multi-month consolidation and, in fact, a strong downward move that allowed our readers to increase their profits.

On the monthly chart, we see that although the ratio moved higher earlier this month, the 61.8% Fibonacci retracement withstood the buying pressure, triggering a pullback.

What impact did this drop have on the medium-term chart?

Light Crude Oil - Continuous Contract Weekly/ Gold - Continuous Contract

Before we comment on this question, let us recall the quote from our last essay:

(…) it climbed to the resistance area created by two important resistance lines: the upper line of the red rising trend channel and the upper border of the long-term green rising trend channel.

(…) what does this have to do with the price of crude oil? As it turned out many times in the past, it has quite a lot in common. Why? As you can see on the above chart, the level of correlation between the price of light crude and the ratio is very high (0.96), which means that the potential reversal in the case of ratio can also translate into a reversal in the case of black gold – just like it has already happened many times in similar cases.

As you see on the above chart, history repeated itself once again as the ratio and crude oil fell together this week, invalidating the earlier breakout above these resistance lines, which gives the bears additional points in the fight for lower levels.

Can we infer something more from the daily chart?

Light Crude Oil - Continuous Contract Daily/ Gold - Continuous Contract

From this point of view, you can see more clearly an invalidation of the breakout above the red rising trend channel and also the sell signals generated by the indicators. At this point, please note that we saw a similar reading of the RSI only once during the last year. Back then, it preceded a correction, which took place in the following days, which means that something similar in the coming week should not surprise us.

Having said that, let’s focus on the seventh solid argument that can be used by oil bears to push the price of light crude down next week. What do we mean? The relationship between crude oil and silver.

Light Crude Oil - Continuous Contract Daily/ Silver - Continuous Contract

In this case, we can also observe an invalidation of the earlier breakout above important resistance lines (the upper lines of the green rising trend channels in terms of intraday highs/lows and daily opens/closes) and the sell signals generated by the daily indicators.

Nevertheless, when we take a closer look at the above chart, we can notice one more bearish sign – rising volume during recent declines, which only increases the likelihood of another move South.

Summing up, yesterday, crude oil invalidated one more breakout on higher volume, which in combination with the picture that emerges after analyzing the current situation in all individual ratios suggests that another bigger move is very likely in the coming week.

If you enjoyed the above analysis and would like to receive daily premium follow-ups, we encourage you to sign up for our Oil Trading Alerts. Sign me up.

Thank you.

Nadia Simmons
Forex & Oil Trading Strategist
Przemyslaw Radomski, CFA
Founder, Editor-in-chief, Gold & Silver Fund Manager

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Source: Equities.com News (September 26, 2018 - 9:30 AM EDT)

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