Crude Oil Outlook:

  • Crude oil prices had been suffering amid news that COVID-19 infection rates were rising in China.
  • However, a rebound transpired amid conflicting headlines regarding Russian missiles landing in Poland, a NATO member.
  • According to the IG Client Sentiment Index, crude oil prices have a bearish bias in the near-term.

China and Russia Driving Price Action

Crude oil prices have had an erratic week thus far, driven by speculation around both supply and demand issues.

On the demand side, news of rising COVID-19 infection rates in Chinese urban areas dampened excitement around the idea that the world’s second largest economy would soon back away from its zero-COVID strategy, providing a boon for energy demand into the end of the year.

On the supply side, concerns around an escalation in conflicts in Eastern Europe regained primacy as Russia launched missile strikes against the Ukrainian capital, Kyiv. Furthermore, conflicting reports around Russian missiles landing in Poland – either intentionally or inadvertently after being shot down – sparked fears of a widening conflict stemming from the Russian invasion of Ukraine.

The net-result has been a sharp rise in crude oil volatility. With the focus on geopolitical issues that could further constrain supply, however, this rise in oil volatility has helped support a rebound in crude oil prices. But the gains by crude oil could be easily wiped out if the reports about the Russian missiles in Poland are clarified or disproved, warding off the inevitable speculation that this event is just another brick in the road towards World War 3 (as some financial and media pundits have prematurely proclaimed).

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Oil Volatility, Oil Price Correlation Still Weak

Crude oil prices have a relationship with volatility like most other asset classes, especially those that have real economic uses – other energy assets, soft and hard metals, for example. Similar to how bonds and stocks don’t like increased volatility – signaling greater uncertainty around cash flows, dividends, coupon payments, etc. – crude oil tends to suffer during periods of higher volatility. However, with oil volatility spiking around fresh geopolitical tensions in Eastern Europe, it may be the case that the correlation between oil volatility and crude oil prices strengthens in the coming days.

OVX (Oil Volatility) Technical Analysis: Daily Price Chart (November 2021 to November 2022) (Chart 1)

Oil volatility (as measured by the Cboe’s gold volatility ETF, OVX, which tracks the 1-month implied volatility of oil as derived from the USO option chain) was trading at 47.43 at the time this report was written. The 5-day correlation between OVX and crude oil prices is -0.40 while the 20-day correlation is -0.11. One week ago, on November 8, the 5-day correlation was +0.20 and the 20-day correlation was -0.30.

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Crude Oil Price Technical Analysis: Daily Chart (November 2021 to November 2022) (Chart 2)

In the prior update it was noted that “crude oil prices attempted a topside breakout last week, only to run into the October high yesterday before turning lower. Now, crude oil prices are back within their multi-month symmetrical triangle, suggesting the bullish impulse has initially failed…triangle support comes in near 86.50, which if broken, could signal a deeper setback for crude oil prices. Otherwise, more consolidation may be ahead.”

Crude oil prices did attempt to break below 86.50, but the return of geopolitical tensions surrounding Russia have helped crude oil prices return back into their multi-month symmetrical triangle. Despite meaningful price swings during November, crude oil prices are now up less than +0.50% on the month (having been up as much as +8.33% and down as much as -2.85%).

Momentum is now effectively flat. Crude oil prices are still below their daily 5-, 8-, 13-, and 21-EMAs, but the EMA envelope is in neither bearish nor bullish sequential order. Daily MACD is falling but still above its signal line, while daily Slow Stochastics are holding just below their median line. It remains the case that more consolidation may be ahead yet.

Crude Oil Price Technical Analysis: Weekly Chart (March 2008 to November 2022) (Chart 3)

Momentum is conflicted on the weekly timeframe. Crude oil prices are below their weekly 4-, 13-, and 26-EMAs, and the EMA envelope remains in bearish sequential order. Weekly MACD is turning higher albeit still below its signal line, while weekly Slow Stochastics are back above their median line. For a bullish reversal to take root, a weekly close above the weekly 26-EMA is likely necessary. Until then, it remains the case that “it’s too soon to take a longer-term directional bias.”

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Crude oil: Retail trader data shows 73.55% of traders are net-long with the ratio of traders long to short at 2.78 to 1. The number of traders net-long is 22.14% higher than yesterday and 35.88% higher from last week, while the number of traders net-short is 7.35% lower than yesterday and 33.16% lower from last week.

We typically take a contrarian view to crowd sentiment, and the fact traders are net-long suggests crude oil prices may continue to fall.

Traders are further net-long than yesterday and last week, and the combination of current sentiment and recent changes gives us a stronger crude oil bearish contrarian trading bias.

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— Written by Christopher Vecchio, CFA, Senior Strategist

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