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What The Oil Market Is Telling You Right Now

By Costas Bocelli October 27, 2011 Facebook Logo Twitter Logo Email Logo LinkedIn Logo

In my article last week -- Recession? These 2 Things Will Let You Know -- we focused on two key industrial commodities that can help us gauge whether the economy may be heading into another recession.

After all, having a firm reference guide can go a long way towards your confidence and conviction when making financial decisions with real capital on the line.

I shared with you how I’ve been intently watching the price action of Copper and Crude Oil, with specific price levels, to help me formulate my own opinions on where the markets and the economy may possibly be heading.

Indeed, late last week my target area on Copper was put to the test.  The red metal traded down to 3.03 per pound, coming within pennies of violating that key area I had my sights on.

Since those lows, and less than a week ago, Copper has surged over 15% and settled at 3.49 per pound yesterday (the intraday high was 3.58) -- a very strong reversal, even making a higher high in the short term.

December Copper Futures

 
Most likely, the main catalyst boosting Copper prices came over the weekend when China reported much stronger than expected manufacturing data.  And when you couple that with recent upbeat regional manufacturing and durable goods data here in the United States -- Copper prices are now firmly above the danger zone.

While we can link the news, reports, and economic data to the moves in the commodity, ultimately the truth lies in the price action.  And the reality is that the price action is painting a rosier picture as to where the economy may be heading in the short term.  We should continue to follow Copper prices, especially if it pull backs and re-tests that key level.

While the Copper market was under assault, testing my “recessional” line in the sand, the Oil market has been relatively stronger.  In fact, while Copper was testing the key lows late last week, Oil traded down to $84.22 per barrel, which is nearly $10 above my $75 per barrel “recessionary” alert level.

Since last week’s low, Oil has also surged higher in a strong bullish pattern.  While it did settle sharply lower yesterday at $90.20 per barrel, it just hit nearly $95 intraday in price earlier this week.

December WTI NYMEX Crude Futures

 

Why has WTI Crude Oil been showing strong relative strength?

There are mainly four factors:

  1. Many sophisticated and professional traders were involved in a “pairs trade” that bought North Sea Brent Oil and sold WTI Oil to profit from a widening spread (a divergence) between the two benchmarks.  Recently, the trade has begun to unwind and the benchmark prices are now narrowing (convergence).  The “unwind” has been putting upward pressure on WTI prices.
     
  2. The economic data has been more upbeat, putting further pressure on rising demand and prices for energy.  The recent China manufacturing data we highlighted earlier was a major catalyst of recent strength as well.
     
  3. Crude inventory levels have been declining, which is generally bullish for Oil prices.  While yesterday’s report showed a surprise larger increase in weekly inventories, the trend has been mainly lower.
  4. The WTI Crude Futures delivery months are in backwardation, meaning near term delivery months (front months) are trading at premium prices to further out delivery months.  Basically, the front month contract (December) is trading at the highest price.  This indicates that the market would prefer Oil sooner rather than later, which infers robust demand.  This type of skew across the board is generally a bullish sign of strength and a precursor to even higher prices.
Weekly Crude Oil Inventories

 
Much like the copper story, the oil trade also paints a rosier picture for the economy in the short term.

The bottom line here is that the recent price action in these two commodities would tend to steer me toward the conclusion that a doom and gloom “recession” scenario is not on the imminent horizon.  And if it does show its ugly head, it will be out somewhere into 2012 or beyond.

What’s the next move?

Based on the strong relative strength in Crude Oil and the Energy space, ever since the market bottomed earlier this month, this sector looks the most attractive with plenty of upside potential.

However, the broad market rally off those lows has been fast and furious and is butting up against resistance.  The best course of action is to be patient and put together a shopping list of compelling names, particularly in the integrated and independent oil producers.  Also, the oil service sector has many promising names and looks equally compelling.

While the market can continue to rally further, the higher probability is that we have some type of retracement or pullback which will bring cheaper prices and higher potential profit opportunities.

We may very well get that opportunity shortly, as the Eurozone tries to figure out the sovereign debt mess.  The recent market run-up has discounted many of the promises and pledges to fix their problems and any missteps will surely disappoint a perfectly priced market.

Based on the recent action in the Copper and Oil market, the best course of action may be to buy on the dip and look for that year-end rally to close out 2011.

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