Crude oil staged a sharp rally late on Friday’s session which must have caught many traders by surprise. After all, the WTI contract had dropped to a fresh 7-year low just the day before. The sharp bounce back ensured that both contracts ended the week in the positive territory. In the case of Brent, the bounce-back was not a major surprise as it had already established a base just below the psychological $50 mark, where it had held for the prior fifteen trading sessions on a daily closing basis. Thus it was likely that many speculators had adjusted their stop loss orders some distance above the psychological level, which were apparently triggered on Friday’s session when liquidity was drying up ahead of the weekend. The bearish fundamental outlook for oil has not changed, however, with crude stocks in the US hitting record highs last week due to the surplus in supply and weaker demand growth. Although news of a record decline in US drilling may have been part of the reason for Friday’s bounce, until there is an actual sharp reduction in shale oil supply – which we think may happen around the middle of the year – oil prices will likely remain under pressure. What’s more, the significantly weaker oil prices have so far had little or no positive impact on the global economy; in other words, there is no sign of a shift in the demand curve for oil to counterbalance the supply curve shift we have seen in the past several months, if not years. In fact, activity at China’s manufacturing sector actually contracted for the first time since September 2012: the official PMI fell to 49.8 in January compared with market expectations of 50.3 and prior reading of 50.1 in December. Separately, HSBC’s manufacturing PMI for the world’s second largest economy was revised down to 49.7 in January from 49.8 initially.
Nevertheless, as a result of Friday’s counter-trend move, we may see some further gains in the short-term. As can be seen from the charts, both oil contracts have now broken their respective short-term bearish trend lines. Brent is currently above the prior resistance of $52.40, so it has potentially cleared the way for a short term rally towards $55.00 or even $58.50, levels that were formerly support or resistance. As things stand, the near-term bias remains bullish for Brent for as long as it can remain above the $50 handle. WTI is likewise holding its own above short-term resistance at $46.50 and it, too, has paved the way for a potential rally towards the next logical resistances at $49.50 and $51.25. Bullish speculators should not confuse the break of the trend lines with a change in the direction of the long-term trend; they simply mean the strong bearish trend has now weakened. Whether or not the long-term bearish trend has also been eroded is far too early to say. For now though the path of least resistance appears to be on the upside, until proven otherwise.