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Crude bounces back: another short-squeeze or is it different this time?

by Fawad Razaqzada

Crude shorts felt the squeeze on Tuesday, as both Brent and WTI contracts bounced off their bullish trends around $47.00 and $43.60, respectively. Ahead of the US stockpiles reports this week and after a 4.5-day sell-off, I wouldn’t be surprised if oil finds a firm base at these levels, although at this stage it is too early to say whether the bounce will materialise into a rally, for after all similar rebounds recently have quickly faded. Indeed, sentiment continues to remain bearish on the oil market, with the International Energy Agency (IEA) for example suggesting in its closely-watched annual outlook on Tuesday that the price of oil will only recover to $80 a barrel no sooner than 2020. But like many other forecasters, the IEA expects non-OPEC supply to fall sharply next year as oil companies continue to cancel or postpone exploration and other projects. So it was a mixed report, which may also help explain the bounce in oil prices Tuesday afternoon.

Bearish traders also booked profit ahead of the US crude stockpiles data from the American Petroleum Institute (API) later on Tuesday. The official Energy Information Administration (EIA) supply data won't be released until Thursday because of the Veterans Day on Wednesday. But we will have some important data from China to watch out for on Wednesday: industrial production. This is expected to have actually risen to 5.8% in October on a year-over-year basis from 5.7% in September. If the actual data deviates significantly from the expectations then oil prices may move sharply in the direction of the surprise.

From a technical perspective, crude’s bounce makes sense. Not only had oil reached short-term oversold levels after a 4.5-day drop, both contracts had reached their respective key support levels too. Brent for example has continually been finding good support around the $47 handle in recent months and Tuesday was no different. There is also a short-term bullish trend line that goes through $47; this provided additional support. On WTI, the corresponding trend and support came in around $43.60, which is roughly where it bounced from on Tuesday.

While both oil contracts could bounce strongly off these support levels, the long-term downward trends still remain in place. As such, one should treat this latest bounce with caution. Until such a time when the longer-term bear trends are eroded, the technical outlook would thus remain bleak. Even if the bearish trends break, it is unlikely that we will see considerably high price levels any time soon, for as soon as prices rise notably, shale producers will no doubt rump up production. So, from these levels, the bulls would do very well to drive prices up by around $10 over the coming weeks. It should be noted also that if the abovementioned supports give way, then the selling could continue for the foreseeable future.

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