Crude Oil Forecast Overview:
- Crude oil prices backed off key resistance mid-month, but have recently found support at the highs seen in November – a good omen heading into 2021.
- The crude oil price rally was stunted by the 48.66/49.31 area, was identified as key resistance in an earlier crude oil price forecast update at the start of December.
- Recent changes in retail trader positioning gives us a bearish bias towards crude oil prices.
Crude Oil Prices Buoyed Near Nine-Month Highs
US fiscal stimulus is arriving soon. Brexit has been resolved. The coronavirus pandemic has peaked, as vaccines are being deployed. All’s well that ends well, at least for financial markets. With several key macroeconomic themes finding positive resolution into the end of 2020, risk appetite has been stoked and energy markets – widely seen as a proxy for global growth – are ending the year on a high note by trading through their March highs.
That’s not to say that global energy supply issues have been resolved. OPEC+ will scale back their production cuts from 8.2 million bpd to 7.7 million bpd starting on January 1, 2021. A survey produced by the Dallas Fed in the beginning of December suggests that the breakeven price for new wells varies between $46 and $52 per barrel, meaning that crude oil prices are in the territory that could draw more supply into US markets.
Keeping these overhead supply in mind, the recent crude oil price rally was capped by the 48.66/49.31 area, previously identified as key resistance at the start of December. What does this mean for traders? While the near-term outlook may be bullish thanks to fundamental tailwinds, and the technicals point to strengthening bullish momentum, traders may want to curb their enthusiasm regarding a significant run higher – at least beyond the February 2020 high at 54.66.
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Crude Oil Price Technical Analysis: Daily Chart (December 2019 to December 2020) (Chart 1)
As discussed earlier, the early-December update suggested that “ff crude oil prices were to make any more gains, breaching 46.26 could trigger what could be a quick trip higher into the area between 48.66 and 49.31, which proved to be a meaningful turning point in February and March during the initial coronavirus pandemic selloff. Coupled with the knowledge that significant overhead supply sits on the sideline, any gains into the 48.66 and 49.31 would be seen as the absolute point for profit taking for bulls.” Since achieving this area on December 18, crude oil prices have traded lower.
But losses following the rejection of resistance have been curtailed, insofar as the November highs around 46.26 have proved themselves as new support; a series of ‘higher lows’ has emerged. The high on December 18 at 49.43 and the low set on December 23 (bullish daily key reversal candle) at 46.16 constitute a new bull flag, and the measured move higher above 49.32 would see a price target of 52.70 in January 2021.
Oil Volatility Slumps, Oil Prices Inch Higher
Crude oil prices have a relationship with volatility like most other asset classes, especially those that have real economic uses – other energy assets, soft and hard metals, for example. Similar to how bonds and stocks don’t like increased volatility – signaling greater uncertainty around cash flows, dividends, coupon payments, etc. – crude oil tends to suffer during periods of higher volatility. Heightened uncertainty in financial markets due to increasing macroeconomic tensions decreases theoretical demand for energy; signs that the global economy is recovering from the coronavirus pandemic reduces uncertainty, and thus, volatility.
OVX (Oil Volatility) Technical Analysis: Daily Price Chart (December 2019 to December 2020) (Chart 2)
Oil volatility (as measured by the Cboe’s gold volatility ETF, OVX, which tracks the 1-month implied volatility of oil as derived from the USO option chain) was last spotted trading at 38.64, hovering around its lowest levels since mid-September. Oil volatility remains far below the yearly absolute high (incidentally the all-time absolute high) set on April 21 at 517.19, and still considerably below the yearly closing high (incidentally the all-time closing high, also established on April 21) at 325.15. Oil volatility is back at levels seen throughout 2019; the situation has been and appears to be poised to remain stable, as has been the case in the second half of 2020.
The 5-day correlation between OVX and crude oil prices is -0.89 while the 20-day correlation is -0.55; and one week ago, on December 1, the 5-day correlation was -0.86 and the 20-day correlation was -0.62. If it’s typical to see oil volatility and oil prices share an inverse relationship, a sense of normalcy has been in place for quite some time: today was the first day since May 14 that the 20-day correlation has risen back above -0.55.
IG Client Sentiment Index: Crude Oil Price Forecast (December 29, 2020) (Chart 3)
Oil – US Crude: Retail trader data shows 48.90% of traders are net-long with the ratio of traders short to long at 1.05 to 1. The number of traders net-long is 3.19% higher than yesterday and 3.29% higher from last week, while the number of traders net-short is 0.09% higher than yesterday and 4.21% lower from last week.
We typically take a contrarian view to crowd sentiment, and the fact traders are net-short suggests Oil – US Crude prices may continue to rise.
Yet traders are less net-short than yesterday and compared with last week. Recent changes in sentiment warn that the current Oil – US Crude price trend may soon reverse lower despite the fact traders remain net-short.
— Written by Christopher Vecchio, CFA, Senior Currency Strategist