Crude Oil: Where Will It Stop?

Another weekend. Another day of confusion for me to think of what to write about. That is because markets are closed on weekends and I do not do analysis of Friday’s markets till Sunday night. So, Friday/Saturday posts I have to write about general interest to me and all my readers. Of course, I could write about cricket but that is my interest and I’m not too sure whether it is also the interest of my readers and subscribers too. And, moreover, there is nothing to write about cricket on a day when India lost to Sri Lanka by an innings and 239 runs within four days. Hats off to Muttiah Muralitharan who ended with 11 wickets in the match! No wonder he has the highest number of wickets in Test matches. And I do believe him when he says that he will end up with 1000 Test wickets in his career. Anyways, since cricket is not on my blogging list, let us shift to the next most important thing – crude.

In an earlier post, I had written that there were signs visible that crude was showing signs of topping out. And in fact, that day turned out to be very close to the final high made in crude. We all know that crude finally broke down a few days later and is now more than $20 off its highs. People are talking of support near $120, some say $110 and some even say $80. I do not have access to charts of crude traded on NYMEX (New York Mercantile Exchange). Hence, I do the analysis based on the charts formed by prices on MCX (Multi Commodity Exchange). Since MCX is an Indian exchange prices are quoted in Rupees.

Seen above is the daily chart of crude since the beginning of 2008 along with a trendline, a couple of Fibonacci Retracement analysis and the Relative Strength Index (RSI). Let us start with things in chronological order. My previous post on crude talked about the presence of various dojis (a day on which the opening price and the closing price is the same or is very close to each other), which made the charts look a little bearish, even though the prices were increasing every day. Also seen on the charts is a bearish divergence between the prices and the RSI where the prices are increasing while the RSI is falling (as marked by the thick trendlines and the brown arrows). Next, let us come to the trendline. The prices finally broke through the trendline three days after that analysis but soon recovered. The trendline was decisively broken about a week later when the crude prices even went below the most recent pivot low. Not only that, yesterday it has decisively broken through the pivot low formed in end of May. What remains to be seen is whether this can be qualified as an intermediate term downtrend or not. Technically, the breakthrough the most recent pivot low and an uptrend line gives quite a bright possibility that the trend may have reversed. However, it is not confirmed till we have a pattern of lower highs and lower lows visible. While lower lows are seen on the chart, a lower high has not been formed as yet. So, we would have to wait for a pullback and see whether the previous highs are broken through or a lower high will be made. Another post on my blog, which did the Elliott Waves Analysis of crude may suggest that an intermediate term high may have already been made.

Let us now see where support is likely. For this purpose I have used Fibonacci retracements. I have used two retracements starting from the lows marked at A and B till the high marked at C. As seen from the chart and the price action in the last two days, support is being found near the 38.2% Fibonacci retracement level of AC and near the 50% retracement level of BC. One possibility is that the prices may find support at these levels and may reverse, which could happen to be a short term (or who knows, a long term) reversal. If the prices do break through these levels, support may be found near 4865 where two Fibonacci retracements of 50% (of AC) and 61.8% (of BC) converge. Support may even be found there. Of course, it may decide to continue going further down. Where it eventually finds support can only be decided by the crude itself and no amount of analysis can say with certainty where the ultimate support would be found.

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The World Around Us

Today is a weekend and on weekends I, usually, write about general things for which I don’t get time during the week. On previous occasions, I have written about mutual funds, the US Recession, Retirement Planning, Greed and Fear, Renewable Energy, Price to Earnings Ratios, Rules for Analysing Charts, why technical analysis works, Fibonacci Techniques and have done a couple of webinars also. The whole week a question keeps propping up in my mind that what am I going to write about this weekend and sometimes my mind draws a blank and I don’t know what to write about. Today happens to be one such weekend. Maybe you readers can give me some ideas about what I should write about. Just send me a list of topics about which you need some more information and I can keep picking up a topic from the list and every weekend I can write about a different topic. I hope to get a list which could last me 2-3 months. So please send in your lists today.

Though, I didn’t know what I should write about, but then I thought why not write about something which seems to be driving our markets. And in my opinion, there are three things that are driving the Indian markets, namely, inflation, crude prices and the American markets. Inflation, I feel, is more because of the shooting commodity prices the world over rather than being an Indian phenomenon. The government is trying to control inflation by regulating the supply of commodities or by raising interest rates but when the inflation is driven by external factors how can we control it with these measures? Though, I’m not much of an economist but I feel there could have been better ways to reduce inflation than this. I’m shocked at how horribly wrong the Govt. was. According to this news report the Central Government had said on April 19, 2008 (when the inflation was 7.14%) that they would bring down the inflation under 5% in the next two months.

Well, about crude prices the sky seems to be the limit to which the crude prices can go? Will this never end? Will crude go to $200 a barrel? When I don’t understand anything I make use of technical analysis. But I have done the technical analysis of crude in an earlier post too with the help of Elliott Waves and had suggested that crude could make a high near 6300 or $148.50. Things have changed today. Crude, after a $10 jump that day slowed down and is now gradually inching up. This gradual increase has pushed the target upto between 6500 and 6600 (in rupees), which means it could go upto $157 a barrel. But I also saw the short term chart of crude and I found it to have some similarities with the chart of the Nifty. Let us see how.

Seen above is the daily chart of the Nifty showing the period between November 2007 and January 2008. Significant in this chart is the presence of dojis. I’ve mentioned in numerous other posts that a doji is a day when the open and the close of the day is the same or is very close to each other. In this case, the candle that is formed has an upper shadow and a lower shadow but a non-existent or a very small body. All such dojis have been marked in the chart above with green arrows. Dojis are signs of indecision/confusion. Such indecisions and confusions cause a strong trend in the market to slow down and then reverse. This is exactly what happened in late January after a series of dojis were seen in late November, all of December and the initial part of January. Another thing to note in the chart is the presence of the ADX index which measures the strength of a trend. A strongly trending stock/index will show higher values of ADX while a trend slowing down or a stock/index going through a consolidation will show lower values of ADX. This ADX, which was as high as 47 in late October came down between 15 and 20, when the Nifty actually reversed.

Let us look at the crude chart for the period between mid May and now. The similarities seen are obvious. This chart also has seen a number of dojis in the last two months, though, may not be as many as were seen in the chart of the Nifty. Looking at the ADX indicator, we can see that here too it made a high of 47 and then came down to levels between 25 and 30 and is now at 33. The striking resemblance between the two charts shows us that the high for crude oil may not be very far off. What also cannot be ignored is the presence of so many red candles. The chart looks more red than blue even though this chart is of a period when it has been in an uptrend.

And lastly, let us take a look at the American markets too. Seen above is the chart of Dow Jones Industrial Average for a period of last one year. We can clearly see that the trend has been downwards. The chart currently shows no indications of the downtrend finishing or an uptrend building up. But there are a couple of things which I want to share with you. The first is the trendline drawn from June 7, 2007 till date. This trendline shows that there may be support nearby near 11100. And a one year long trendline, which has been tested 4 times in the past should provide a pretty strong support. Secondly, the Relative Strength Index (RSI) is currently near 20 and considering that the downtrend has been in place for the last 9 months, a level of 20 is highly oversold which has never been seen in the last year, at least. Both these things show that a support, could only be a short term support, is nearby. And that is what we are expecting with the Indian markets too. More downside possible but a short-term low may have been formed.

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Inflation and Crude Oil Technical Analysis

The topic of my discussion today is crude oil. But because of the increasing oil prices we saw a hike in the prices of petrol. That will increase the inflation, so let me talk about inflation. With increasing inflation, the markets will come down, so let’s change the discussion to the markets. But this oil price increase may be because of the weakening dollar. Shall we talk about the dollar then? There are so many things to talk about, why limit ourselves to one topic. I’ll just write type whatever comes to mind.

Let us take a very simple example. Let us assume that milk and cows are not easily available commodity/animal. Let us assume that you have 5 cows with you (lucky you) and that you get about 50 litres of milk a day. Since milk is not easily available you don’t want to sell it all and would like to keep some for your future use, so you freeze it. And since your neighbours are buying from you, you sell about 28-30 litres in a day, consume 2 and freeze the rest. Now, your cows are getting old and their milk giving capacity is going down. You know that in a few months time you will be left with no milk. Your neighbours are requesting you to start selling 40-45 litres a day. Obviously, you won’t do it because when the cows stop giving milk, you could charge a fortune for a litre of milk.

Now let us say that the cows will give milk only for 6 months more, which is 180 days. At your current rate of 20 litres a day, when the cows stop giving milk you would have 3600 litres of frozen milk with you. The neighbours have been paying you with a kilo of rice for each litre of milk. But rice is easily available and its value is going down. And because of the value of rice going down, you have started asking for 1.2 kg of rice for every litre of milk. And because you are selling less your neighbours are even willing to pay 1.5 kg of rice for a litre of milk. You know that your 3600 litres of milk which was worth 3600 kg of rice, will now get you 5400 kg of rice. So, in effect you are richer by 1800 kg of rice without doing a thing. Would you sell more milk or just keep building up your wealth which is now increasing without even selling?

This is exactly what is happening in the world today. Just substitute crude oil for milk, the oil rigs for the cows, the Arabian countries owning the oil rigs for yourself, the rest of the world for the neighbours and the US dollar for rice. It is all so simple. Why would they sell more oil when their net worth is increasing every day because of the depreciating dollar? Why would they sell more when they know that 20-30 years down the line when the production is zero, the crude will be worth much more? Why would they sell more when they could get a fortune for a barrel of oil 30 years down the line?

Inflation jumped to 8.24% for the week ended May 24, 2008. On Wednesday, the government hiked the price of petrol by Rs.5/- per litre, diesel by Rs.3/- per litre and LPG by Rs.50/- per cylinder. The government says this hike could increase the inflation by 50 or 60 basis points. But inflation is not only affected by fuel price hike. This fuel price hike will have a cascading impact on all sectors from industries to agriculture and even services. The worst hit, as is easy to understand, will be the transportation sector. It will also mean increased house rents because the cost of construction material will be pushed up by the cost of transportation. And since almost everything needs to be transported before and after production, this hike would affect everything. In time, the food will also becoming dearer, and now with the LPG hike even cooking the food is going to become costlier.

The Economic Times says that historically a Rs.2/- per litre hike in petrol and Rs.1/- per litre hike in oil pushes up the wholesale price index by more than a point in the subsequent two weeks. The LPG price had not been increased since 2004 and this time with a Rs.50/- per cylinder hike in LPG and Rs.5/- and Rs.3/- hike in petrol and diesel respectively, the wholesale price index could move up about 4 points (though the Economic Times says only a point and a half) in the week ended 7th June, the figures for which will be released on 20th June, 2008. This would push the wholesale price index to about 234.5 to 235. A figure of 235 would translate into an inflation of over 10.48% since last year in June the Wholesale Price Index was 211.8.

Coming back to crude, the crude price jumped by more than $10 a barrel on Friday to a record high of $138.54. Did the government do something wrong in increasing the petrol, diesel and LPG prices? Absolutely not, but it came too late. This was a decision which should have been taken months ago. With the reformist finance minister, Dr. Manmohan Singh heading the government, we didn’t expect such a good economic decision to come so late in the day. But maybe the government was just waiting for the Karnataka assembly elections to get over. But the decision took more than 10 days after the elections to be announced. Every single day was adding up several crores of rupees of losses for the oil companies. But in the end such a drastic hike was a bold decision by the government. But despite that, Petrol sold in India is still about Rs.10/- per litre cheaper than what price it commands in the rest of the world. But where is it headed? $150 a barrel is not too far away and there even have been predictions of $200 by the end of the year. Let us do some technical analysis.

Seen above is the daily chart of crude oil near month futures listed on Multi Commodity Exchange (MCX) in Rupees. In this chart we are not taking the help of any line studies or indicators. The only thing on the basis of which we are trying to predict is the Elliott Wave Theory. Applying the Elliott Wave counts to the above chart, we can see that we are currently in the 5th wave. All waves have been marked as 1,2,3 and 4. 0 is where we have started the wave count from. You can also notice that within wave 3 also there are 5 waves which have been numbered in brown colour to avoid any confusion. Wave 1 was Rs.1076/- long while the length of wave 3 was Rs.1838/-, which clearly shows that wave 3 was the extended wave. This means that wave 5 should be, more or less, as long as Rs.1076/-. From the end of wave 4, this gives us a target of Rs.6288/- per barrel for crude when wave 5 ends. A target of Rs.6300/- would translate into a price of $148/50- per barrel in dollars. There the crude should, rather, could make a short term high, at least.

More tomorrow. Happy Investing!!!

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Nifty Breaks Important Support

Before I start this edition, I must apologize for not being able to post my views on this blog on Thursday night for Friday due to some personal problems. Rest assured, I’ll try to be as regular as I’ve been in the past. I’ll continue with my plan to post a newsletter for every market day and an extra on a weekend. The Nifty, on Friday, did open slightly in the green but soon started losing ground. It managed to hold on to the support between 5000 and 5050 for a couple of hours but soon after noon it started slipping quite heavily and from there it was a unidirectional decline for the Nifty.

The chart of the Nifty has suddenly changed in the last two days. If we ignore the last two candles in the chart, we can see that we were pushing against the resistance line and the blue candle had a long lower shadow which showed that the price did go down but buying came in at lower levels and that actually took the price past the day before’s close. Suddenly, that day was followed by two red candles which changed the chart completely. Now we have broken through the support line near 5000, as signified by the solid green line, which is highly negative. A lower high is now already in place and below 4913 we will have a lower low too, thus signifying the start of a new downtrend according to the Dow Theory. According to the trendline theory, we have now entered an intermediate term downtrend. The target for this downtrend may be somewhere between 4500 and 4550. However, support also comes in at previous lows of 4913, 4630 and 4470. There is a reasonable good support at current levels near 4950. It is important that the previous low of 4913 is not broken if we are want some stability in the markets.

A lot of the current fall in the markets has been attributed to inflation which has been on the rise due to the jump in prices of crude oil. Crude Oil has almost doubled in the last 10 months and the jump has been exponential in the last two months. What actually has been happening in crude oil? Is it likely to come down? Well, some people say it is likely to come down now and there are others who say a price of $150 per barrel is likely in the next few days. Who do we believe? The best thing, I would believe, is to look at its chart and decide for ourselves.

Given above is the daily chart of crude oil futures as traded on the Multi Commodity Exchange (MCX). The price is in Rupees but the chart, whether in Rupees or in Dollars will remain the same. As seen in the chart, the thick red line is the line chart (close) of crude oil and we can see that it has now found some resistance near 5650 near the blue line. We can see that the support trendline is too far down near 4800 (which will reach 4900-5000 by the time the price comes down). A fall to 5000, though, may not be possible but a fall to 5100-5150 is likely. 5150 also happens to be the 23.6% Fibonacci retracement level of the rise seen from the February lows. That would correspond to roughly $120 per barrel. Also embedded on the chart in the gray line is the chart of Gold futures on MCX (the scale for Gold has not been shown). As seen by the chart, the price of both Gold and Crude is moving in tandem and a fall in crude could also make the yellow metal cheaper.

Buying should be avoided for now since the short term trend is now down and it is likely that the intermediate trend may also turn to down, if it already hasn’t. Keep strict stops on all open long positions.

Happy Investing!!!

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