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Long-Term and Short-Term Outlook for Oil

My long-term outlook on oil hasn’t changed for more than a year. The long-term patterns are still bullish, despite the lack of movement in oil recently.  The short-term outlook is a bit more bearish, as we could well see a move to the downside before the price continues higher.

Currently, I am not positioned in oil futures, but I do own a handful of oil stocks, which I purchased in early 2016 near the bottom.

Outlook for Crude Oil

My long-term outlook on crude oil remains bullish for a number of reasons.

Mainly, oil stocks and the commodity itself have experienced the crash already. With the major selloff behind us, I believe there is a little risk of another one in the near future. 75%+ declines in oil (2013 to early 2016) are rare to begin with, and are not followed by declines anywhere near the same magnitude). That doesn’t mean there can’t be short-term drops back to $45 for example, but a drop back below $30 is highly unlikely.

Below $30 we saw capitulation selling and complete disillusionment on the part oil investors. That sort of disillusionment only comes after a prolonged decline. Any selloff that happens from here is likely to be more muted and on a much smaller-scale.

In early 2016 I shifted my focus to buying oil and gas stocks. I continue to hold those positions, and price action in crude oil has me believing that crude will continue to head higher, along with most oil stocks…over the long-term.

Technically, I like the reversal that we saw in 2016. After a prolonged decline a big rally occurred, and that rally erased the entire prior down wave that occurred in late 2015. The definition of a downtrend is overall lower swing highs and lower swing lows. As of mid-2016, that was no longer the case. The price made a higher swing high, negating the downtrend. The price then pulled back several times throughout 2016, creating higher lows, and then proceeded to make new highs (albeit barely).

Figure 1. Crude Oil Continuous Chart

crude oil outlook

This could just be called a reversal, it could also be viewed a large cup and handle bottoming pattern, and there is a also a head and shoulders reversal pattern extending back to late-2015.

The next move higher in oil should take the price into the $65 region.  My long-term target is $82, which is the area I will unload my oil stocks. How long-term targets are attained (and adjusted over time) is a topic for another day.

Having an outlook that confirms my current positions is nice, but I also must consider what would prove me wrong, or what other scenarios could develop.

Other Oil Scenarios

I do feel there is a moderate possibility of the price oscillating in a big range between about $55 and $45 over the next several months. The price has obviously struggled above $50, and what bothers me is how many other people are now expecting the price to go higher. A year ago everyone hated oil, and now every hedge fund seems to love it. Commitment of Traders (COT) data shows speculators have accumulated their largest long positions since 2013. To me, if these guys are already in and the price hasn’t moved up, then we very well could see a big shake-out to the downside. A move back down into the $49 to $47 region would probably be enough to scare some of these speculators out of their positions. As long as we stay stay above the $43 (April contract), I am not too worried. Even a slight dip below $43 wouldn’t bother me.

Figure 2. Continuous Crude Oil Chart with COT Data

(The blue line is large speculators, such as hedge funds. The red line is commercial companies, like oil producers. Green line is swap dealers. Notice how the large speculators (blue) push the price, but also how they have their largest/smallest positions before the market reverses. So we could see those positions (blue line) drop, along with the price, before another big move to the upside).

cot chart for crude oil
Crude oil with COT data – click to enlarge

A sharp drop below $43 (on April contract) that doesn’t quickly recover would be worrisome (equivalent to a drop below $40 on the above chart). Can also just look at the August lows, on whatever crude oil chart you are viewing. A drop below the August lows wouldn’t fit within the context of an uptrend, and also, moves like that are atypical of an upside reversal in oil.

There is also always the risk of a “shock.” For example, a conflict could send oil flying higher, despite the short-term outlook.

Conclusion on Oil

I have my thesis that this is an uptrend in oil, and the charts (at least how I view them) confirm this. My next price target is the $65 region. At that point I would expect another pause or major reversal….all just part of the ups and downs of an overall uptrend.

In the short-term though, I am bit concerned about how many large speculators are bullish on oil. They have been buying and buying and price hasn’t moved up recently. There is a good chance the market will slaughter a lot of these guys before the uptrend continues. If that occurs, the price could decline toward $45/47, creating more of a ranging environment. This would not nullify the uptrend. The long-term outlook would be bullish, and if I get another opportunity to buy some oil stocks (and oil futures) in the $45-$47 area, I am taking it!

What would change my view is a sharp drop below August 2016 lows. On the April contract that is $43.97. A minor drop below that isn’t a big deal.  Markets have a tendency to create “false breakouts” — a slight drop below a major level, followed by a surge back to the upside. So a drop to $43 for example, wouldn’t change my bullish view, assuming the price rallies back up fairly quickly.

If we keep dropping below that, though, that is a problem and I would need to readjust my view and my exit points on the oil stocks I own.

Oil stocks also have a life of their own sometimes. Oil should not be relied on exclusively to tell a trader how their oil stocks will perform. When doing my analysis, I analyze the individual companies as well the price oil. I find this helps me make better decisions on when it is time to buy and sell oil stocks.

By Cory Mitchell, CMT – Trader, investor and author of the Stock Market Swing Trading Course.

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