View: Brent resistance solid at $115, near-term strength should be sold
Following our last update on Brent in early September (http://wp.me/p1G1Fr-cr) we got the immediate move to the downside we were looking for (10% or so), but the selloff never quite ran to the extent we’d hoped, instead bouncing aggressively from the October 4th low at $99.11 (based on the CO1 chart from Bloomberg) right back to the top end of September’s trading range. In fact, the market was just 10 cents shy of the top of channel resistance before the rally faltered last week.
We’re sceptical this recovery marks the start of a push back to the highs of the early summer though. There remain plenty of headwinds for crude to face. Slower global growth the principle factor although there are new dynamics at work in the US too, specifically the impact of shale gas (and perhaps soon shale oil). Those fretting over Middle East risks – which have stoked prices since the spring – might also be sleeping a little easier following Israel’s prisoner swap for captured soldier Gilad Shalit which hints at some thawing of tensions there, while in Libya the capture/demise of Gaddafi should be a watershed for the country, oil production had already resumed (albeit short of earlier capacity) helping rebuild some spare capacity. We imagine that recent US accusations that Iran plotted with a Mexican drug gang to assassinate the Saudi ambassador at his favourite restaurant – which was partly a catalyst to the move up to the October 14th high @ $114.80 – will fade back towards fiction too.
Short Brent also offers exposure to the dollar’s broader performance. Although a recovery in risk appetite and corresponding dip in the DXY has left the bears bloodied this month, cyclical positives should be coming into play for the dollar and in turn take some more of the froth out of commodity markets. Specifically we look to the diverging prospects for growth between the US and Europe and narrowing interest rate spreads.
This all adds to support for the technical picture which now looks more bearish again. The recent push higher failed to surpass those September peaks keeping that pattern of lower lows in place from late April. Furthermore the recent low, at least on a closing basis – which is more important – was also below the May/Jun and August bottoms. Currently the drop back has stalled at the $108.70 support line but this isn’t that substantial a level. It might be strong enough to provide room for a short-term bounce back into the $111’s but we’d expect to see sellers step back here.
The ultimate objective should be a renewed decline that would take the market down through the $99.11 marker. Note the base of the channel is well below $95.00 now, a level we think Brent should trade through before year-end. Our earlier target of $80.00 still looks viable longer-term, but first things first. There is key dependent to this scenario though, that the DXY holds above support which currently spans 75.85/76.30 which we’ve identified a number of times. If this falters a move back above $115.00 is likely, although we wouldn’t be tempted to chase that given trends elsewhere in the commodity complex (copper on the first chart specifically).
- Oil seen over US$100 in 2012 despite weak economy (business.financialpost.com)
- Guest Post: Who’s Right About Commodities: Bears Or Bulls? (zerohedge.com)
View: Sub $80 Brent realistic as growth weakens/dollar gains
Firstly, our past analysis has focused on WTI, but as has been well documented in recent months this is very much a broken contract and has fading merit in its use as a potential economic barometer. One only has to look at the chart below to see that the relationship with petrol prices – which WTI previously moved in lockstep with – broke down at the end of last year. Those filling their cars up at the pump and WTI are no doubt well aware of this already; policy makers should also take note – releasing supply from the strategic reserve doesn’t do much, aside from creating arbitrage opportunities for physical traders. In this piece we focus on brent.
Brent has held up better in recent weeks but this as looks as much an opportunity as curse. Economic data is hardly positive from a demand perspective. Of course demand from the developing world and Asia will continue to increase over the medium-term but softening demand out of the US and Europe now should be enough to rebuild a supply cushion which in turn will take some of the froth out of prices. Speculative demand also risks being squeezed further as market falls trigger outflows from investment funds, volatility increases and more importantly the market re-prices in the face of a strengthening dollar.
Technically the risk reward looks good from current levels. Brent is not that far from recent highs based on typical volatility in this contract. Indeed, the base of the current trading range is close to 96.70 vs. the 111.58 area we’re currently trading and realistic targets based on a more pronounced correction (built around our core macro views) are closer to $86.70/$91.85 initially and below support there $80.00, which proved to be something of a pivot level during the latter part of 2009 and throughout 2010. We’d be happy running shorts while front month trades sub 116.80/117.00 and for those with slightly deeper pockets $120.00. Perhaps this is one for the gold bugs who no doubt expect gold to shine as risk aversion increases. We’re not so convinced by this argument but would prefer to be short brent than gold and if long gold short brent too which should provide a hedge against an extension of the dollar rally.
The wildcard remains geopolitics of course; Libya production is set to remain below potential due to damage incurred during the now concluding civil war. Tensions elsewhere remain high with Syria important at a regional level. Tensions between Turkey/Egypt and Israel are of course not helpful and there is Iran and Bahrain was not too long ago topping news sheets. However, it should be noted that many of the earlier tensions were exacerbated by rising commodity, specifically food, prices. If we’re right about a shift in the dollar these as a driver of stress in the region should also pare back.
- Crude on the Wide – Why? (zerohedge.com)
WTI has been making modest headway over the past couple of days, underpinned by some recovery in risk appetite which has lifted the whole industrial commodity complex. To clear out the remaining bears we’d need to see Nymex crude (CL1) clear resistance at $98.91 and $100.18 which would leave the path clear to try and crack $102.89 and push on to the more solid looking $105.47 area. Mid-term we still believe higher levels will present a selling opportunity but shorter-term feel patience is needed, shifting our stance from our June 29th update where said fading rallies in the $95.00-$100.00 zone offered good risk/return dynamics. Now only a close below $94.32 would shift the bias lower again and in the interim there is a good chance we see oil in triple digits again. An alternate scenario that would turn us bearish would be an advance in the dollar index above 76.90, providing that is crude prices are still up here at that juncture.
- Oil Daily Outlook July 19 (businessinsider.com)
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