The energy sector has found a bit of life over the last several weeks but we believe this to be short lived. While crude oil futures did push to new highs for the move on Friday, they failed to hold their gains and closed lower on the day. Furthermore, petroleum products like unleaded gasoline and heating oil failed to make new highs Friday, leaving the end of August short covering snap back as the highs for both of these products. Among these three markets, heating oil is currently the most likely to lead the next leg down. We normally, prefer a shorter timeline to provide greater detail of the current situation however, the importance of the downward sloping trend line coming down from the June highs is too important to leave out as you’ll see on the chart below.

Commercial traders in the heating oil market attempted to support prices at $2.40 nearly a year ago, even building a record long position. However as the market fell through the July of 2012 lows, they quickly unloaded much of this inventory as the market fell through January of this year. Since then, the market has meandered sideways as the effects production cuts and drawdowns are weighed against the prospects of future demand. Finally, commercial traders began to become bullish again this June, continuing their buying even as the market fell to new lows once again, this time at $1.39 and its lowest level since 2009. Ultimately, their buying led to a new net long record and tipped us off to the end of August buy signal.

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There are a couple of important points to make on the market’s recent rally. First, as mentioned above, the high for the move remains the reactionary short covering rally high at $1.70 made on August 31st. Secondly, commercial trader purchases ahead of this rally triggered the COT buy signal ahead of the jump. Third, commercial traders turned sellers IMMEDIATELY. Commercial traders have been sellers in five out of the last six weeks, shedding more than 20,000 contracts at trend line resistance. Finally, over the last week, which is unfortunately tough to see at this scale, has created a bearish divergence between price and momentum. Most importantly, continued commercial trader selling as well as Friday’s potential reversal in the crude oil market confirms this divergence.

We’ll be selling heating oil futures this week and placing a protective stop at Friday’s high of $1.6643 in the December contract. The heating oil market has been the weakest of the petroleum markets on this rally and we expect it to slide through early December. Will this mean a new low? We’re not sure. As always, if we can get the market moving in our anticipated direction, we’ll manage the position closely. Recent volatility will certainly provide more than one opportunity between now and December.