Crude oil has been on the move, rallying to a five-month high above $86 a barrel on May 3, 2010. While the market will of course see some corrections, consumers now face the question heading into driving season: can oil reach $100 or beyond, revisiting the record high set in 2008?
A popular theme for commodities in the first half of 2008 was the demise of the U.S. dollar, which helped send crude oil to a record high of $147 in July of that year. In 2010, a flight to the dollar has been the theme, and commodities have been bullish nonetheless.
Daily headlines impacting crude oil prices include the oil spill crisis in the Gulf, an increase in consumer spending and manufacturing, and the further emergence of China in the global economy. The Institute of Supply Management’s April factory index hit its highest levels since 2004, and first-quarter gross domestic product gained 3.2 percent.
One cannot forget that the U.S. is the world’s largest consumer of crude oil, and most analysts expect to see the economic recovery progress with stabilization in unemployment and an increase in job creation.
Technical strength has also paved the way for continuous rallies in the energy complex. We are currently seeing gasoline lead the way as it tries to test $2.6 – $2.7 a gallon, making new highs week after week. On Monday, May 3, NYMEX June gasoline (RBOB) futures settled at their highest level since September 2008.
Currency Impact
The question remains whether this market is getting toppy. I want to first focus on the rise in oil that has come in conjunction with a rise in the dollar. Debt problems sweeping the Eurozone have created a flight to the U.S. dollar. Europe has committed to an IMF bailout of $145 billion for Greece, viewed as a positive step. Whether this is a long-term or short-term solution remains to be seen, but this does show progress. Investors hope that this problem will not be revisited. I believe the bailout will relieve some of the tension that continues to drown the euro, at least for the next few months.
From a technical standpoint, the dollar is significantly overbought, the June ICE dollar index futures contract has run into a major resistance area between 82.50 and 83. I believe the euro will inevitably find support above $1.30. As these two currencies find their respective resistance and support, I think we will see crude oil, which is priced in U.S. dollars, find it easier to sustain rallies and head through $90.
When taking a longer-term look at crude oil demand, you cannot avoid the fact that China is the world’s second largest consumer, and India is ranked number four ( 2008 U.S. Energy Information Administration statistics). These counties are only GROWING. Additionally, it is no secret that many analysts and market participants feel the Chinese yuan is undervalued. Imagine the yuan increasing in value relative to the dollar, now making it cheaper for the Chinese to buy the dollar-denominated crude oil.
The Technical Argument
Now for some of the technical aspects that are driving this market. I want to point out that the December crude oil contract (a deferred contract) has been leading the way. A 50 percent retracement from the $145.07 highs and the $52.90 lows in this contract finds a level of $100. Given that December is trading around $92, I think the rally should have a bit further to go from a technical standpoint. What I like even more about that move is that the front-month will have to follow suit and ride December’s coattails to new yearly highs. June and July have retracements that give these contracts room for another $10 to $11 before they sees $100. One could try to argue that this market is too overbought already, but a key momentum indicator, the Relative Strength Index (RSI) is at the same level now as it was when this market was $10 lower.
While seasonal factors can’t always be relied upon to repeat, I will also note that dating back to 2006, the time period between the first week of March and the last week in May has been bullish for energy. Gasoline has seen an average range upwards of almost 80 cents, with the bulk of the move coming in May. This leads me to believe that there is a good chance gasoline futures may be heading to test $2.60 – $2.70, a heavily traded area on the way up to $3.63, and on the way down from there. Keep in mind, when looking at seasonal tendencies in any market, there are usually underlying fundamental circumstances that cause futures prices to move in a certain directional manner at certain times of the year. When you are considering trading markets affected by seasonal trends, these factors are generally already reflected in market prices.
As I have covered what I believe to be the main factors driving crude oil, I can conclude that we are looking to see this market test $100, and stick its head above the century mark. There are still opportunities for crude oil bulls, and many strategies to consider depending on your goals risk-tolerance. Please feel free to contract me with any questions you might have about this or other markets.
William Baruch is a Senior Market Strategist with Lind-Waldock. He can be reached at 888-341-2071 or via email at wbaruch@lind-waldock.com.
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