Let’s Have an Oil Chat (USO)
It’s taken a heckuva long time, but the day has finally arrived.
After losing close to 60% of its value between July, 2014 and January, 2016, and falling below $40 a barrel, oil has now begun a move higher that we believe marks the end of its downtrend and very likely much higher prices over the short to intermediate term.
But before we get to the charts that illustrate the new reality, we’re going to digress briefly to discuss the fundamental backdrop that’s boosting oil prices the world over.
Bear with us. It’ll take but a minute.
First up is OPEC member Venezuela, a nation literally circling the drain. In the next few weeks the country will officially be declared bankrupt, as both excuses and cash run out, and payments on its debt are left unpaid.
With both production and refining in that country also about to grind to a halt, the market will look very severely at the near term shortages caused by the bankruptcy. And even though any number of other nations will attempt to fill the supply breach, there’s no gainsaying that a domino will have fallen.
China in the Lurch
Particularly hard hit by Caracas’ carnage will by China, whose oil-for-loan deals with Venezuela will put the world’s second largest economy in something of a pickle. Increasingly, China will be forced to turn to the spot market to fill any shortages, and that will likely make for increased price volatility in an already bumpy market. As of today, China is also the world’s second largest consumer of heavy crude.
Next is asset flows. As mentioned, after trailing the rest of the investment world for the last year, crude has now started to edge higher, and that should shortly spur an initial wave of retail buyers. It’s our opinion that the most recent technical breakthroughs for oil (see chart below) will convince the vast majority that the time is at hand to rotate one’s arse assets into that sector in a meaningful way.
Indeed, it’s already started.
As the following chart indicates, the ‘smart’ money began buying into the slick liquid back in July… and never stopped. All told, position increases of better than 45% into all things oily and gaseous have been transacted over the past four months (white circles, below).
And that has brought us to new highs for a barrel’o’muck.
And higher analyst estimates for what’s to come.
Have a look –
Since offering their lowest expectations in more than a year, analysts are have now found cause to cheer. With supplies being used up faster, and new supplies – and drilling – coming on slower, there’s a good chance that demand into 2018 won’t be met with the same robust tankage we’ve seen for the last few years.
And with OPEC production cuts holding – and expected to be extended through the end of 2018 – we could see great buoyancy in the crude trade over the next twelve months, spurring both ma and pa to climb aboard, too.
Now take a look at NYMEX Crude, as represented by the United States Oil ETF (NYSE:USO).
There are a number of important items to discuss here.
- Foremost among them is the fact that price has now popped above all her moving averages (in red). We would add that this is the first time this has occurred in 40 months. There have been several attempts to pop above the long term (yellow) moving average in the interim, all of which failed.
- What’s equally encouraging is the bunching of the longer term moving averages around USO $10.50, a line of solid resistance for nearly six months. That bunching is generally a precursor to the MAs rolling over (higher), a development that could take place as early as December if crude manages to hold its current gains.
- As the latest bottom, in June, was set, a reverse head and shoulders pattern also began to form, and is now complete regardless of how one draws the neckline. We’ve diagrammed both possibilities for you (in blue), and would add that the upside count for the move would bring USO to either $12.25 or $12.75, depending on the neckline chosen. Either way, we’d be free of the congestion area that formed in the $11.50 range at New Year’s (black box).
- Finally, RSI and MACD indications are both bullish, as they’re above their respective waterlines, and the weekly RSI and MACD markers are THIS VERY WEEK surfacing. This is extremely bullish, and confirms the positive divergence we’ve seen from the daily RSI (in green) for the last half year.
The Wild Card
Before we get to the trade, just a word about today’s increasingly volatile geopolitical direction. In a word, where there’s oil, there’s tension. And that means not only the Middle East, where Saudi Arabia, Qatar, Iran, Iraq and a host of other nations seem headed toward an internecine conflict that could disrupt oil flows, but Nigeria, Libya and North Korea, too.
Tensions in these areas could very easily throw existing drilling and shipping regimes into disarray.
And that, of course, would be price positive.
So how do we trade it?
We’re going to use the above mentioned USO to make a bullish call on oil’s prospects, and we’re going to go long/short at current price and support levels in order to minimize our costs and reduce our risk.
And it goes like this –- Content protected for Normandy Executive Lounge, Wall Street Elite, Executive Lounge members only]
Wall Street Elite recommends you sell the USO July 20th 10 PUT for $0.52 and use the proceeds to purchase the USO July 20th 12 CALL for $0.53. Total debit on the affair is a penny.- Content protected for Normandy Executive Lounge, Wall Street Elite, Executive Lounge members only]
Note well, that USO’s share price is now $10.85, and all we’re betting on is a marginal move higher to make this trade meaningfully profitable.
With kind regards,
Hugh L. O’Haynew