Another Tropical Storm Bails Out the Oil Market

• Tropical storm Delta heads for Louisiana- Crude oil bounces from a marginally higher low
• The $40 pivot point remains in play- Crude oil under pressure as the potential for risk-off rises
• Another stimulus package could lift all commodity prices, and crude oil is no exception

Markets tend to look like they will explode higher when rallying, and like an implosion is on the horizon when prices are moving lower. Commodities are one of the most volatile asset classes. As the price range in a commodity market narrows, small moves to the top or bottom end of the band can cause expectations for a significant technical breakout or breakdown.

After falling to the lowest price in history in April 2020, when NYMEX crude oil futures fell below zero, the price of the energy commodity recovered steadily until early June. NYMEX crude oil then settled into a consolidation pattern with $40 per barrel as a pivot point. The memories of the price carnage earlier this year caused the market to become extremely nervous when prices are moving towards the bottom end of the price range. Like many other markets and commodities, crude oil often takes the stairs higher and an elevator shaft to the downside during bearish periods.

On October 2, crude oil fell to its lowest price since early September when the November contract reached $36.63 per barrel. Another hurricane heading for the Gulf of Mexico caused the price to recover to over the $40 level last week. The United States Oil Fund (USO) follows the price of a portfolio of NYMEX WTI futures contracts higher and lower.

Tropical storm Delta heads for Louisiana- Crude oil bounces from a marginally higher low

Last week, Tropical Storm Delta strengthened into a Category Two Hurricane as it moved into the Gulf of Mexico. On Wednesday, October 7, the hurricane slammed into Mexico’s Yucatan Peninsula and was moving north towards the US Gulf Coast. A hurricane watch from High Island, Texas eastward to Grand Isle, Louisiana, included Houston, Galveston Bay, and points in Louisiana, including New Orleans. On October 9, the storm slammed into the Gulf Coast states.

On October 2, the crude oil futures market was under pressure, but the storm packing winds of over 110 miles per hour caused the price to bounce back to its pivot point on fears that the hurricane would cause damage in critical energy infrastructure regions along the Gulf Coast.

Source: CQG

As the daily chart highlights, the price of November NYMEX crude oil futures fell to a low of $36.63 on October 2, just five cents above the September 8 low and first level of technical support. The hurricane caused a bounce back to above the $40 level and to a high of $41.47 on October 9. The November contract settled at $40.60 last Friday.

The $40 pivot point remains in play- Crude oil under pressure as the potential for risk-off rises

The daily chart shows that crude oil traded mostly above the $40 pivot point from early June through the end of August. The price moved to a high of $44.05 per barrel on August 26. From September through early October, the price had been mostly below the $40 level as bearish sentiment returned to the energy commodity.

Open interest, the total number of open long and short positions in the NYMEX futures market had been rising since mid-September, and the price leaned to the downside. The metric rose from 2.023 million contracts on September 23 to 2.115 million on October 5. Increasing open interest when the price of a futures contract is trending lower tends to be a technical validation of a bearish trend.

However, the storm caused the total number of open long and short positions to decline to the 2.050 million contract level at the end of last week. Hurricane Delta likely caused speculative shorts to close their risk positions. Price momentum and relative strength indicators were above neutral territory at the end of last week as the price was above the $40 pivot point. Daily historical volatility rose from just over 31% at the beginning of October to over 52% on October 9 as the daily trading ranges widened.

Hurricane Delta likely lifted the crude oil price, but bearish factors continue to lurk in the background. The rising number of coronavirus cases in the US and Europe threatens the demand side of the fundamental equation for the crude oil market as it heads into a traditionally weak time of the year during the winter months. Moreover, the November 3 US election is, among many things, a referendum on energy policy in the world’s leading crude oil-producing nation.

President Trump supports a continuation of the drill-baby-drill and frack-baby-frack policies. Democrats support more regulations and replacing fossil fuels with alternative energy sources that leave less of a carbon footprint on the environment. Voters will decide on the future of US energy policy in the election, which could add volatility to the oil futures arena. The potential for risk-off price action in markets across all asset classes over the coming weeks and months could significantly impact the crude oil market that tends to take the stairs higher and an elevator shaft to the downside.

Crude oil futures have been on the staircase since the late April low at $24.43 on the November contract and over $50 lower on the nearby contract as it fell below zero.  A break below technical support at $34.36 on the weekly chart could open the floodgates to technical selling in the energy commodity.

Another stimulus package could lift all commodity prices, and crude oil is no exception

Last week, President Trump walked away from the negotiating table when it comes to another stimulus package. While the markets moved lower after the move, another injection of government help is likely coming in the immediate aftermath of the November 3 election no matter which candidate wins. However, the risk is that there is no clear winner, and the process of counting votes continues for weeks or months.

Meanwhile, stimulus has become a political hot potato, and both sides continued to exchange proposals at the end of last week. When the stimulus finally arrives, it should support commodity prices, and crude oil is no exception. Stimulus and central bank liquidity increase the money supply and erode the value of all currencies, including the US dollar.

I believe that the period from 2008 through 2011-2012 is a model for 2020 and the coming years. While the reasons for monetary and fiscal policy in 2008 were different from 2020, the levels this year are far higher than a dozen years ago. Increasing the money supply is inflationary, and the Fed has already told the world they will tolerate inflation at above its 2% target rate. In 2008, crude oil fell to a low of $32.48 per barrel. By 2011, the price was near $115.

Crude oil could experience another ugly selloff, but the price is likely to come storming back as inflationary pressures rise over the coming months and years. For the short-term, Hurricane Delta seems to have temporarily stopped the bearish price action in the oil futures market. However, the potential for another risk-off period is rising, so fasten your seatbelts for the short-term.

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The U.S. Oil Fund LP (USO) fell $0.29 (-1.01%) in premarket trading Monday. Year-to-date, USO has declined -72.30%, versus a 10.24% rise in the benchmark S&P 500 index during the same period.

USO currently has an ETF Daily News SMART Grade of D (Sell), and is ranked #67 of 112 ETFs in the Commodity ETFs category.