- A stretched rubber band eventually snaps
- The range in crude oil has narrowed over since early October
- Three factors that could move oil higher over the coming weeks
The price of crude oil was trending lower since late April when the nearby NYMEX futures contract hit the high for 2019 at $66.60 per barrel. Increased US production caused the price of the energy commodity to decline to a low at just above $50 per barrel in early June. In July, the price bounced to just over $60, but it quickly retreated to just above $50 again in early August. On Friday, September 13, the price was at just under $55 per barrel. The September 14 attack on Saudi oilfields that temporarily knocked out half of the Saudi’s production caused a brief spike to a high at $63.38 on September 16. Since then, the price dropped back down to below the $51 per barrel level again. At just under $57 per barrel at the end of last week on the now active month December NYMEX futures contract, the memories of the mid-September attack that caused the price spike to the upside have faded into the market’s rearview mirror. However, the reason for the attack remains a clear and present danger for the crude oil market. In October, the price of December NYMEX futures has traded in a range from $50.89 to $56.74 per barrel. The narrow trading range reminds me of a rubber band that is being pulled in opposite directions. Eventually, it will snap, leading to a significant price move. The United States Oil Fund (USO) is a liquid ETF product that moves higher and lower with the price of NYMEX crude oil futures.
A stretched rubber band eventually snaps
Try an experiment. Take a rubber band, hold it on either side, and pull in opposite directions. At some point, the material will no longer take the stress, and it will snap. Unless you are wearing gloves, the snap will cause some pain. Markets that trade in a narrow range can be like rubber bands. When they decide to move below support or above technical resistance, the price move can be substantial. The longer a market sits within a range, the more dramatic the price trajectory can be when it decides to move.
The range in crude oil has narrowed over since early October
The crude oil market is like a rubber band these days. It looks bullish at the top end of the trading range and bearish at the bottom. During October, the trading band of $5.85 compares to a range of $10.28 on December futures in September, $7.63 in August, and $5.76 in July. September was an outlier month because of the rally caused by the drone attack on Saudi production.
The narrow range in the oil market from high to low over the past months is a sign that the rubber band is stretching and could snap sooner rather than later.
Three factors that could move oil higher over the coming weeks
I have favored buying dips in the crude oil market when the price heads towards the $50 per barrel level on nearby NYMEX futures. The first reason for my stance was the reason crude oil spiked higher in September. Iran remains a provocative problem in the region of the world that is home to over 50% of the world’s oil reserves.
The second reason is the optimism over trade between the US and China. The potential for a “phase one” agreement that would de-escalate the trade war would reduce fears of a global recession and increase the demand for crude oil and other raw materials.
Finally, OPEC will meet at the beginning of December. The cartel’s policy these days is a combination of Russian and Saudi output plans. The Saudis had said that its sweet spot for the Brent crude oil price is from $60 to $70 per barrel. Meanwhile, both Saudi Arabia and Russia need to see the price of the energy commodity higher. At the $62 per barrel level at the end of last week, the price is at the bottom of their desired range. As the December OPEC meeting approaches, the odds of a deeper production cut above the current 1.2 million barrel per day level are rising.
I continue to believe that risk-reward favors the upside in crude oil when the price approaches the bottom end of its trading range at the $50 per barrel level. When the rubber band snaps, it is likely to be on the upside like we witnessed in mid-September.
The United States Oil Fund LP (USO) fell $0.01 (-0.09%) in after-hours trading Tuesday. Year-to-date, USO has declined -3.58%, versus a 14.08% rise in the benchmark S&P 500 index during the same period.
USO currently has an ETF Daily News SMART Grade of A (Strong Buy), and is ranked #1 of 109 ETFs in the Commodity ETFs category.
About the Author: Andrew Hecht
Andrew Hecht is a sought-after commodity and futures trader, an options expert and analyst. He is a top ranked author on Seeking Alpha in various categories. Andy spent nearly 35 years on Wall Street, including two decades on the trading desk of Phillip Brothers, which became Salomon Brothers and ultimately part of Citigroup. Over the past decades, he has researched, structured and executed some of the largest trades ever made, involving massive quantities of precious metals and bulk commodities. Aside from contributing to a variety of sites, Andy is the Editor-in-Chief at Option Hotline.