Is Oil's Rally Already Over?

Last week, I wrote in these pages that I expected a bounce in crude oil. After a dramatic decline since the beginning of the year, WTI futures looked to have finally found a bottom just below $50 and a retracement of some kind looked to be on the cards. Up until yesterday, that looked to be a good call, with the main WTI futures contract, CL, hitting a high just over $54.50 in intraday trading.

Then, as quick as it began, it started to look like the rally had ended.

CL reversed course and dropped back below $53. That has caused me to revisit that call, but there are both technical and fundamental reasons to believe that this is just a normal, temporary retracement and that the upward path will resume soon.

From a technical perspective, anybody who is familiar with the concept of “dojis” won’t be surprised to see oil trading lower this morning. A doji is candlestick on a chart that resembles a cross. It is formed when, after a day of some volatility, the underlying instrument closes at about the same level as it opened. That indicates a battle between buyers and sellers during the day, a battle that in this case, the sellers won.

Dojis are often reversal points following a move, and I suppose that could be the case here, but there are good reasons to believe that isn’t the case.

First, if you look again at the chart and focus on the last week or so, you will see that the move up has not been in a straight line. In fact, until yesterday’s action eked out a positive close, there had been daily changes of intraday direction. Despite that, crude had managed to maintain an upward trend. There is no reason to think this time will be any different.

From a fundamental perspective, the case for a retracement that I laid out last week hasn’t changed.

One of the main causes for the drop has been the fears about coronavirus and its effects on the market, but, while the response to the outbreak could have a temporary effect on oil demand, that is more a reaction to the headlines than anything.

It sounds scary, for sure, but when the actual impact of the disease is compared to more common illnesses such as the flu, it is not that great. The history of similar things, like SARS and MERS, indicates that the fuss will all die down before long and the market will move on. Given that, today’s news that the number of fatalities from coronavirus has increased is neither surprising nor, in market terms, particularly worrying.

In that context, the most notable thig is that even as the headlines have gotten scarier over the last week or so, crude has started to retrace the move down. That indicates an underlying strength that is presumably still there.

So, the answer to the original question of whether oil’s rally is over is probably not. Traders understand that this too shall pass and are looking further ahead than the next headline, so a move back up above $55 looks much more likely now than another challenge of the $50 level.