Crude Oil Outlook:
Omicron and Ukraine
There are two factors that have ungirded crude oil’s strong performance at the start of 2022.
First, COVID-19 omicron variant concerns have faded into the backdrop as the reduced lethality of the virus doesn’t pose a significant risk to the ongoing global economic recovery. As mentioned numerous times previously, the correlation between quarterly global oil production and quarterly global GDP is a robust +0.97 over the past 30-years.
Second, heightened tensions among Russia, Ukraine, the United States, and Europe (the EU and the UK) have provoking speculation that energy supplies could be impaired shortly. There is, in effect, a speculative supply-demand imbalance that could see global energy demand outstrip supply in a meaningful manner should the war of words escalate into boots on the ground.
Both of these factors appear to remain at the forefront for the foreseeable future, providing plenty of fuel to crude oil price’s strong bullish momentum.
Oil Volatility, Oil Price Correlation Flips
Crude oil prices have a relationship with volatility like most other asset classes, especially those that have real economic uses – other energy assets, soft and hard metals, for example. Similar to how bonds and stocks don’t like increased volatility – signaling greater uncertainty around cash flows, dividends, coupon payments, etc. – crude oil tends to suffer during periods of higher volatility. There is an exception to the rule, however: oil prices tend to track volatility higher when geopolitical tensions flare.
OVX (Oil Volatility) Technical Analysis: Daily Price Chart (January 2021 to January 2022) (Chart 1)
Oil volatility (as measured by the Cboe’s gold volatility ETF, OVX, which tracks the 1-month implied volatility of oil as derived from the USO option chain) was trading at 41.34 at the time this report was written. With tensions in Eastern Europe escalating – threatening to reduce short-term energy supplies – the uptick in volatility in recent days has coincided with higher oil prices. The 5-day correlation between OVX and crude oil prices is +0.84 while the 20-day correlation is -0.29. One week ago, on January 20, the 5-day correlation was -0.66 and the 20-day correlation was -0.91.
Crude Oil Price Technical Analysis: Daily Chart (November 2020 to January 2022) (Chart 2)
The near-term technical outlook for crude oil prices remains bullish. Daily MACD is rising through its signal line, while daily Slow Stochastics are holding in overbought territory. Crude oil prices are above their daily 5-, 8-, 13-, and 21-EMA envelope, which is in bullish sequential order. Of note, crude oil prices have not closed below their daily 8-EMA since December 20, 2021, suggesting a ‘buy the dip’ mentality is best suited. The next swing target higher is the OPEC+ fiscal breakeven level of 92.00.
Crude Oil Price Technical Analysis: Weekly Chart (January 2008 to January 2022) (Chart 3)
In late-December it was noted that “crude oil prices have cleared several key levels of technical resistance in recent days. With crude oil prices above their weekly 4-, 8-, and 13-EMA envelope, which is in bullish sequential order, traders may eye further gains when the calendar flips to January 2022.” This view has been strengthened through the first three weeks of the year, and traders may be well-suited to continue to look for further crude oil strength in the near-term.
IG CLIENT SENTIMENT INDEX: CRUDE OIL PRICE FORECAST (January 20, 2022) (CHART 4)
Oil – US Crude: Retail trader data shows 36.45% of traders are net-long with the ratio of traders short to long at 1.74 to 1. The number of traders net-long is 4.75% lower than yesterday and 7.73% lower from last week, while the number of traders net-short is 0.82% higher than yesterday and 13.26% higher from last week.
We typically take a contrarian view to crowd sentiment, and the fact traders are net-short suggests Oil – US Crude prices may continue to rise.
Traders are further net-short than yesterday and last week, and the combination of current sentiment and recent changes gives us a stronger Oil – US Crude-bullish contrarian trading bias.
— Written by Christopher Vecchio, CFA, Senior Strategist