Investing in Crude Oil: What's Next? $65 or $85?
By S.R. Nunnally, Commodities & Resources Report
Yesterday, I sat in the chair in front of a very expensive camera under lights that are a bit brighter than I’m used to at 7:30 a.m.
Joe Kernan, from CNBC’s Squawk Box, was asking me a simple question: $65 or $85?
My answer? Neither.
Of course, we were talking about oil prices, and looking at what’s been happening just since the start of July, it’s an easy answer to give. Since July 2, oil prices have climbed in nearly a straight line, up more than 6%. But that straight line has pushed oil prices near its record high of $77.03 from July 14, 2006.
Yesterday saw a pullback from those high levels, and we were watching oil prices fall in the early trading hours Monday morning, which prompted Joe’s next question: “It looks like we’re headed for a massive double-top formation. Wouldn’t you agree?”
Not necessarily… Pull up this Barchart.com oil futures chart and follow along.
A double-top formation looks like an “M” with a rise to a high, a drop to a valley, and a second rise to a high. This second high should be at the same level as the first, or at least within 5% of each other.
So far, oil appears to be forming this bearish pattern.
But in order for this formation to truly be a double top, prices would have to drop below the low point of the valley. That should be around $51.11.
It is way too premature to call oil’s price movement a double-top pattern.
Now, will oil prices see some resistance as it approaches that high from last July? Absolutely. It already is. But oil has far too many external supports for any retracement to take prices back down to $51.11.
Since we’re talking technical, let’s look at the support points lined up to keep oil prices high (using the September future’s chart from above):
· $72.16: A gap down from last September provided slight resistance back around July 9. That resistance turned to support and spurred oil prices to test its record high.
· $70: From March through June oil prices traded range-bound between $65 and $70, the same range prices traded in before the huge drop in January. Prices pushed past this consolidation level, and now that level will provide a solid floor for support.
· $65-$67.50: This represents the middle of the two former trading ranges, and the bottom of that range.
In fact, in looking at these movements, another pattern emerges: an inverted head-and-shoulders formation.
This formation is bullish. Charles Bulkowski, author of The Encyclopedia of Chart Patterns, says this formation is a “3-valley pattern with the middle valley below the others. The pattern should look like an inverted person’s head and shoulders, proportional, and not lopsided.”
In oil’s case, the shoulders could be the consolidation periods from last fall and this spring.
The straight run to test its previous record high could be the breakout from the pattern. Inverted head-and-shoulders patterns have an average rise of 38% from the breakout point. This point is measured at the “neckline,” or the level where the left shoulder ends or the right begins.
Based on the oil future’s chart I’ve provided, the breakout point was at approximately $71.10. Oil prices have clearly surpassed that level. If this pattern holds true, and gains its average rise, oil prices could potentially rise to $98.12.
Barring any severe supply disruptions or cataclysmic event, we won’t see $98-a-barrel oil this season, but we won’t see $51-a-barrel oil, either.
So, I ponder: $65 or $85?
My answer’s still neither. Watch for support in oil prices at $72 a barrel with a move back to $76.50 by Labor Day. We may see a glimpse of $78 or $80 -- but only a glimpse.
One final note… Want to learn more about chart patterns? Visit Charles Bulkowski’s Web site.
You can also catch me every Monday morning at 7:30 EST on CNBC’s Squawk Box.
S. R. Nunnally
About the Editor: S.R. Nunnally is the commodities expert and technical analyst for TFN's Commodities & Resources Report. As countries such as China and India demand more resources, today's commodities boom will continue to grow. And as the editor of this free e-letter, S.R. will keep you up to date on the commodity and natural-resource market -- and show you how to profit from it as well. Gains like the 26% on Paladin Resources, 38% on Tyler Resources and 19% on St. Elias Mines. Sign up for the free e-eletter Commodities & Resources Report to be part of today's commodities boom.