Sometimes Things Work as They “Should”

Hopefully readers were able to take advantage from what turned out to be two extremely well-timed recent posts on the upside potential for crude oil (admittedly the timing was just a case of luck). We recommend checking them out again if you missed them, as they are laying out the “very lonely” bullish case in detail (see: “Is Crude Oil Close to a Low?”, and “More on Crude Oil and Industrial Commodities”).

Now that crude oil has provided us with something more than just tentative signs of life (it has rallied by approx. 25% in just three trading days), we want to briefly comment on the recent action. First of all, after such a huge advance in a mere three trading days, one should expect some backing and filling, so there is probably no hurry to jump aboard the train if one has missed the recent move.

The most important thing is however the information the recent move has conveyed:

Click on picture to enlarge

WTI crude, daily

As you can see from our annotations above, there are two very positive points to be made from a technical perspective. First of all, the breakdown to a new low was firmly rejected by the market. A so-called “false breakdown” is usually a highly reliable bullish signal (just as a “false breakout” is a highly reliable bearish signal). You could say the bears overplayed their hand, and the market let them know it.

Secondly, the advance produced three daily candles that are known as “three white soldiers” in candlestick analysis. This is considered a very bullish formation. Note also the strong expansion in trading volume accompanying the three white soldier candles, identifying the move as a likely “kick-off” to a bigger rally.

Market Structure

Meanwhile, a look at the spot market and the nearest futures contracts reveals that the contango has continued to shrink. We wouldn’t be terribly surprised if backwardation were to make a comeback in the near future. For instance, the spot price and the October future are already trading at the same level, so the front month no longer sports a premium.