Crude oil surge lacks conviction, seeking reversal signal to initiate shorts

WTI crude oil surges 8% in four sessions
Volumes accompanying the move were ordinary, suggesting limited conviction
Fed interest rate decision, US inflation report and IEA monthly oil market update create significant risk event on Wednesday

The bullish signal in WTI crude oil I was seeking came to fruition late last week, delivering a sharp rebound that accelerated on Monday. But despite renewed optimism surrounding the economic health of the world’s largest crude consumer, the United States, you can’t escape the fact that OPEC producers are set add barrels to the global marketplace from October, while monetary policy settings across the developed world remain in contractionary territory, restraining activity and limiting crude demand.

For that reason, I revert to selling rallies after the latest squeeze higher. Despite the bullish price action, chasing the rally looks a poor one from a risk-reward basis.

Patience paid for recent WTI long

You can see the bullish engulfing candle that sparked the rebound last Wednesday on the daily chart. That was the signal to get long. In the subsequent sessions, we saw the rally stall briefly on Friday as a red-hot US nonfarm payrolls report curtailed Fed rate cut bets, sending the US dollar sharply higher as yields ratcheted higher across the entire US Treasury curve. But that minor pullback was followed by yet another bullish engulfing candle on Monday with WTI surging more than 3%.

The move was apparently sparked by hopes for stronger demand for downstream crude products such as gasoline and diesel during the key US driving season, helped by a bullish Brent crude forecast from Goldman Sachs for the September quarter. But the same bullish forecasts based on the same premise are seen every year, and not just from Goldman. Excuse the pun, but this lowly analyst isn’t buying it even though the market apparently did.

I suspect the move was driven by adjustments to positioning ahead of Wednesday’s US inflation report, FOMC interest rate decision and IEA monthly oil market update. Mediocre volumes accompanying the bullish move suggests as much. Conviction does not look particularly high.

Crude runs too hard, too fast

Despite the bullish price action, for mine, the price has run far too far to warrant joining in at these levels. The risk-reward for doing so screens as poor. So, as was the case early last week when I was waiting for a bullish signal to buy, I’m now waiting for a bearish one to sell.

One level I’m watching is $78.60. The price did some work either side of it May and early June, acting as support and resistance during that period. Should WTI push back towards that level, I’ll be looking to see whether it can continue to grind higher towards the 200-day moving average, a level it struggled to overcome in April and May despite an arguably firmer fundamental backdrop.

If the price can’t break this level or delivers some form of obvious topping pattern before reversing, that will be my trigger to initiate shorts targeting an initial target of $76.15.

-- Written by David Scutt

Follow David on Twitter @scutty

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