Looking Ahead: Crude Oil and Natural Gas

• Posted by Greg Harmon
• on December 21st, 2010

As a reminder, this series of articles as a collection are intended to help frame the potential outcomes of the coming 12 months or so of the global markets. They are not intended to be a forecast per se, but to provide longer term deeper insight based on the current market structure. Each article is complete in itself, but the series together will provide a whole world focus, and as usual they will focus on price action, meaning there will be charts. Full schedule is here.

Crude Oil

Inflation is a major influence on the US economy and the stock market. Crude Oil, since it is priced in US Dollars, is often a good indicator of their health and direction, despite also having supply and demand aspects as a universally consumed commodity. I have used West Texas Intermediate Crude, WTIC, to monitor this commodity. The WTIC chart is below.

This monthly chart exhibits some very bullish aspects. First, the price trend is now moving up after being stuck in a range for over a year. The SMA’s are all pointing higher. Second, the RSI, after moving back above 50 in mid 2009, has retested that level and held a couple times. It is also now moving higher. Next, it is making new 2 years highs and testing the 50% retracement of the move down from 2008, with 61.8% expected if it breaks. Finally, and most interesting, the Bollinger bands have moved from a width of about $125 at their peak in 2009 to $20 today. This is ready to make an explosive move and the indications are that it will be higher.

WTIC – Mid term target of 112 – 120 and long term target of 148 – 167

Four different price forecasting methods put the target at over $110/barrel. First, notice the large move from 17 to 147 from 2001 to 2008, followed by a large pullback. from a simple symmetry perspective if you were to add the 130 move to the base of 35 a target of $165/barrel is obtained. Second, within that last move higher, RSI went from 50 in January 2007 to 81.9 with a stall at 70. During that move the price of Crude Oil moved from $60 to $147 with a stall at $100/barrel. The rise to the stall represents a $40 dollar rise and would create a price target for the current move of about $120 from the base of 80. If the RSI gets to the 82 level again it would suggest that $167 is possible. Next using simple Elliot wave rules, the third wave III must end higher than the first, requiring at least 148, and is never the shortest. Wave V, somewhere in the future could be the shortest of course, but wave I is often the shortest. This would mean it would not be out of the realm of possibility from an Elliot Wave perspective to suggest that wave III stops above 165, similar to the first method used. Finally, using Fibonacci arc analysis, drawing the arcs from the move up from 2001 to 2008, the first arc arrested the down move at the beginning of 2009, and that arc intersects the two rising trend lines that form a cone at 112 and 148. A quick move would expect a more direct rise to 148 while a slower move would anticipate a ride of the trend line to 112 where it could then break through the Fibonacci arc and rise to the top of the channel in a longer time period. For those of you that like point and figure charts the 3×1 with 1 point box size has a current price objective of 105.

Natural Gas

Natural Gas has been the anti-oil with supply rising and price often related to weather as it is used for heat in much of the country. This makes it an important input cost and therefore another indicator of the frothiness of the economy. Below is the monthly chart.

The set up on this chart shows a long 16 year rising trendline at support, and more recently a channel down trendline over the last 3 years, after putting in a double top in mid 2008. The initial convergence of these two in mid 2009 provided support for a run to the top of the down channel. Notice though that particular run could not get the RSI back above 50, where it was during the entire bull move from 1995 to the second top. Note also that the 20 month SMA has fallen and is now leveling but the 50 month has just crossed the 100 month SMA lower, and price is below the 20 month SMA. Additionally the Bollinger bands have tightened quite a bit from the wide extreme of $13 at the 2009 low to about $2.50 now. This also sets up for a big move soon. You can see from my chart that I project that move to be down. This comes from combining the move in the RSI to holding below 50 and the recent down trend remaining in tact with the shorter term weekly chart which shows a 12 month long descending wedge, as illustrated below.

Natural Gas – Long term target of 1.70 – 2.00

I expect Natural Gas to reject at the downtrend channel again and move over the next 4-6 months down to the rising trend line. It should meet the trend at 3.25 -3.30. From there the Bollinger band should be reached and break down through the rising trend could launch it lower to 1.70 – 2.00 before the RSI touches near 30 and slows or stalls. There is support in this range from 6 touches from 1996 through 2002.

Crude Oil against Natural Gas

A final note about these two fuels. Much has been said about the ratio of Crude Oil to Natural Gas being at historical extreme values. Below is a long term chart of this ratio.

There is a clear upward trend in this chart that does not look to stop soon. Interestingly for those that thin the ratio is overvalued, plug in the lowest target for crude oil above, 112, and the highest target for Natural Gas, 2.00, and a ratio of 56 is obtained. This is double the current extreme value, but perhaps what the tightening Bollinger bands on the ratio chart are foreshadowing.

(As always you can see details of any individual charts and more on my twitter feed and on chartly.)

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The information in this blog post represents my own opinions and does not contain a recommendation for any particular security or investment. I or my affiliates may hold positions or other interests in securities mentioned in the Blog, please see my Disclaimer page for my full disclaimer.

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