Picking tops and bottoms in markets is dangerous business. After all, the trend is your friend as they say. But, at some point, all markets must turn. Is it time to catch a falling knife in crude oil?
Crude oil futures chalked up heavy losses over the past year and a half. From the June 2015 peak above $107 per barrel to the August 2015 low at $37.75 per barrel, nearby Nymex crude oil futures tumbled a whopping 65%! Ouch. But, then again if you were short the crude oil market –that was a nice ride.
Trending markets can potentially offer futures traders a nice easy ride. Orderly trends with higher daily highs and higher daily lows can offer traders the opportunity to enter trends with well-defined entry and stop loss points. At tops and bottoms, however, the chart patterns can become murky and more difficult to trade.
Traditionally, one signal of a potential top or bottom for a market is heightened volatility as the trend becomes less orderly and the bulls and bears fight for control. The key question for a bottom formation is has a market dropped far enough to generate "demand" or encourage active buyers back into the marketplace?
The boom and bust cycles of commodity markets. When it comes to crude oil, or any commodity, these markets generally move in major bull and bear cycles. Higher prices encourage more production –which leads to more supply. Inevitably, the higher supply will pressure prices lower. Eventually, once prices fall low enough, producers will stop producing as much as their profits margins decrease. It can be a big boom and bust cycle that occurs over and over again.
As third quarter earnings results begin to hit the news, energy companies are expected to be among the worst performers. S&P Capital IQ estimates a 66% decline in year-over-year operating earnings per share for the energy sector. This has impacted what's happening in the oil fields.
Are we seeing lower crude oil production in the U.S.? Yes. Through late September, the Energy Information Administration (EIA) estimated U.S. domestic oil production has slowed by 475,000 barrels per day over the last three months. The plunge into lower crude oil prices has significantly impacted domestic energy production and cut sharply into energy company's revenue streams. Big picture, the crude oil market still has some excesses to work off globally. Current estimates from the EIA suggest global supplies exceed demand by more than two million barrels per day. These things take time.
More energy needs ahead. While there are great strides in alternative forms of energy from geothermal to wind to solar to electric, for now, the world still runs primarily on fossil fuels. Planet earth is home for about 7.2 billion humans right now. Looking ahead, world population growth is forecast to increase at an explosive rate to more than 9 billion by 2050, according to United Nations estimates. That is a lot of future energy needs down the road and for now fossil fuels are still the main game in town.
Watch the charts. There has been a lot of chatter in the crude oil community about the long-term bull trendline on the monthly Nymex crude oil chart, shown in Figure 1 below. A rising bull trendline is drawn off the December 1998 low. The crude oil futures market plunged to test that trendline in December 2008 as the global financial crisis was beginning to implode and then again in late 2014.
Did we get "confirmation?" Crude oil has broken this trendline and in September posted a monthly close just below the line. But, markets like to test. And, the long "buying tail" seen at the August monthly bar reveals eager buyers below the long-term trendline. Bargain hunters are running amok and sniffing around at this long-term trendline. It's not going down without a fight and some testing. Generally for "confirmation" of a trendline break, especially one of such long duration, two consecutive settlements (or in this case two monthly closes under the trendline) would be needed to confirm the long-term trend change.
Crude oil this month. Will bargain hunters and bottom pickers support the market? Crude oil futures and energy company stocks have been beaten up badly. Domestic U.S. crude oil production is already responding to the lower prices with a decrease in activity and lower supply. Sure, the global economy still shows slack demand for crude and everyone's worried about China's economy. But, just like commodities, economies move in boom and bust cycles. At some point, maybe sooner than you think, demand for crude may start to outstrip supply again.
Figure 1: Monthly Nearby Crude Oil Futures Chart. Source: Market-Q.