Crude Oil Trap

The price correlation between the Crude and equity Cycles was on full display last week.  The only real difference is the relentless nature of Crude’s surge higher.  Crude was so oversold and bearish sentiment so elevated, that its march higher from the Investor Cycle Low has been unyielding.  On the surface, this appears to be bullish, but I feel the setup is ripe for a Crude Oil trap.

The action appears to be a classic bear market squeeze, as traders who bet big on a continued decline have been forced to cover their Shorts.  And in the process, Crude’s mood has quickly turned.  The mood was bleak and extremely bearish just a month ago, but we’ve now begun to hear opinions that the bear market has ended and that Crude has seen the bottom.

Don’t believe it.  In my opinion, the current bear market is still in its early stages, and the current move higher is just a sentiment-clearing event.  I will concede, however, that the move higher is strong enough that it is likely to continue for some weeks.  I am targeting early April for a top.  In the shorter term, however, there is the potential for a Daily Cycle Low (DCL), one that will shake the confidence of the bulls.

Daily Chart

The size and speed of the rally in energy producers – over 30% in a few weeks – confirms that a new Investor Cycle (IC) is underway.   As a result of the move, the percentage of energy sector stocks showing a bullish P&F (BPENER) chart has hit a record 95%, matching levels not seen in many years, if ever.  The BPENER level is a testament to the extreme nature of the recent rally, and provides a reason to be cautious now.

In the past, every Crude IC top has corresponded with a BPENER level of over 80%.  It’s well over that now, but since it appears that the current rally has serious speculative power behind it, I believe that the current elevated reading is likely to persist for some weeks.  Still, the level of the indicator suggests that Crude Oil has entered the topping area of the IC, and it is unlikely that the current IC can continue more that 3-4 weeks higher.

The weekly and monthly charts always allow us to better understand short-term action.  They also provide needed perspective to day and swing traders, who can form powerful and unfounded biases from their observations of short-term moves.

This recent Crude rally has been both powerful and convincing, but we must appreciate that it is only a short-term rally.  On the weekly timeframe, it is an inconsequential blip in a much larger and more enduring bear market decline.  Just 4 weeks removed from a 17-year low, Crude has given us only a mean-reversion rally so far and is now setup to provide a crude oil trap for unsuspecting bull.s

Crude Weekly Chart

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On a String

An excerpt from this past weekend report within the Equities section.  Consider membership here:  Financial Tap

In equities this week, it makes sense to focus purely on technical analysis. During the past few months, I’ve outlined the likelihood that equities are well into a bear market decline that should last for 3-5 Investor Cycles (12-18 months). At this point, I don’t believe it makes sense to rehash it again.

Last week’s report was titled “All On the Same Side” to illustrate just how one-sided the markets had become. Not surprising then, equities bounced after forming a failed Daily Cycle and becoming very oversold.  Since the January 20th Daily Cycle Low (DCL) had already confirmed a failed Investor Cycle, the failure of a following Cycle (on Feb 11th) was not a surprise. The Cycle failure was simply an extension of an already-apparent larger degree correction. However, as with every asset class, equities are subject to ebbs and flows on shorter time-frames, so a Daily Half Cycle Low rally was expected (past 8 sessions).

I noted previously that a 2^nd half rally might be sharp, but would fall just short of the high from day 8. It is too early to know if the half cycle rally is finished, but a final Daily Cycle should always form a lower high before it begins a final decent into a deep Cycle Low. Since the current DC has failed and is only on day 22, without a new high, we can only assume that the coming weeks will bring a sizable sell-off into DC and IC Lows.

We expected a sizable rally, but need to avoid allowing it to flip our thinking to the bullish side – the bear is still very much alive. More than anything, the current rally has allowed oversold technicals and bearish sentiment to reset themselves from extreme levels. In a downtrend, counter-trend moves like we’re seeing at present act as profit taking events before the decline continues.

In this case, the rally has allowed the market to reset to a position where a sell-off into a deeper, final ICL can begin. There is always the chance that a market will go against a well-defined Cycle picture by rallying prematurely without a clean final Daily Cycle low, but that’s the exception and not the rule. At present, it does not look good for the bulls, and the Cycle count does not support any type of bullish outcome. I expect that equities will decline into a mid-March ICL before being treated to a large, counter-trend rally.