Canny traders should look to buy crude oil on the correction
CRUDE’S inexorable rise over the past few weeks in line with rallying equity markets pushed September Brent through the $70 a barrel mark in intraday trading yesterday, touching a session high of $71.28. Signs of an improving world economy and resilient Chinese GDP growth as well as relatively upbeat second quarter earnings in the US have given the oil surge an extra boost. Oil bulls are hoping that equity markets will continue to drive the oil price higher.
But contracts for difference (CFDs) traders wanting to jump into crude oil contracts should be asking themselves how much more upside there is left in the oil price, and whether they might unfortunately find themselves catching only the tail end of the rally.
Alastair McCaig, senior derivatives broker at WorldSpreads, certainly thinks that if you’re not already long of crude oil, then you have missed the boat somewhat, at least as far as the current rally is concerned. But that doesn’t mean that those with long positions in crude oil should look to reverse immediately and go short.
Instead, he suggests that you should consider staying in the position until the price hits the $72-75 mark, when you should look to take your profits off the table and wait for a corrective pullback in the market.
Those still on the sidelines should also be waiting for this pullback from the $72 level back down to about $67.50 and then look to buy on the dip.
“You don’t want to go chasing the market where you are buying at the top of the run,” he warns. Traders wanting to get back into the crude oil market should therefore be patient and keep looking for these opportunities to re-enter the trade.
STRONG CHARTS
The fundamentals are still suggesting a move lower for crude in the short-term but the charts are looking quite strong, says Richard Perry, chief market strategist at CFD-provider Central Markets.
He says: “On the technicals, crude oil has found support and you are looking for a retest of recent highs. The short-term signals are still looking quite positive and will be challenging that resistance level of $73.49.”
He explains: “Momentum still looks strong as seen in the MACD (moving average convergence/divergence) indicator and the price has broken back above the 20-day moving average – historically this has been quite an important basis of resistance and support and the 20-day moving average had been falling for the whole of July.”
While the fundamentals might indicate a correction in the near-term, medium-term positional CFD traders should take note that Morgan Stanley commodity analysts are staying very constructive on longer-term oil fundamentals. They are maintaining their $85 forecast for 2010 despite the fact that shorter-term, increased risk appetite may continue to trump near-term inventory concerns.
Regarding the long-term outlook, they write in a research note: “An inability to add production will act as a binding constraint on demand – higher prices will be required to ration demand and encourage all supply.”
Goldman Sachs analysts are even more bullish. They expect that improving oil fundamentals later this year will provide a sustainable upside catalyst to oil prices and maintain a price target of $85 a barrel for West Texas Intermediate crude for the end of this year.
CLOSE LINKS
But while CFD traders should be watching the oil market closely, the close links between equity markets and crude oil at the moment mean that traders should be paying particular attention to the second quarter earnings results from London-listed oil majors that are due out this week.
BP will report this morning at 7am while Royal Dutch Shell is scheduled to publish before the market opens on Thursday. Deutsche Bank analyst Lucas Herrmann maintains a Buy rating on both stocks but cautions that BP will report net income substantially down on that of the prior year because of the collapse in hydrocarbon prices.
He also expects that the second quarter will have been “very difficult” for Shell. “Soft demand for gas in Europe combined with further disruption in Nigeria suggests a further decline in volumes while in the downstream, refining markets have proven very challenging,” he explains.
A disappointment from either of these big players – BP forms 8.2 per cent of the FTSE 100, while Royal Dutch Shell is 2.6 per cent – could see a short-term reversal in fortunes for the London oil and gas sector as well as giving the crude price a severe knock and could have a real influence on the market.
This would provide an excellent buying opportunity for CFD traders, who could equally look to buy individual oil stocks on the dips as well as crude oil itself.
PRECISION TIMING
However, you need to pick your stocks carefully and time your entry into the market with precision. Worldspreads’ McCaig says that with BP you would be looking to buy on a pullback to about the 505p level.
Smaller stocks such as Tullow Oil might be a bit more adventurous but also a little bit more rewarding. However, he warns that if you are looking to place a trade you would want to see Tullow’s share price move up to about the 1,050p level before correcting to the 950-975p mark, at which point you should look to enter the market, providing you are happy with the rest of the trade.
The oil markets have been pulled upwards by the rally in global stock markets and mounting signs of an economic recovery. While it might be too late to enter the market right now, bearish fundamentals in the short-term will provide ample opportunities for canny CFD traders.