Oil Inventories Hitting Critical Levels

I wrote a post on 23rd April arguing that from an economic point of view the ongoing war between the US, Israel and Iran was largely irrelevant as the only thing that really mattered was how long the Strait of Hormuz would stay closed, and the risk that the Bab al-Mandab Strait might also be closed.

That was almost six weeks ago, and we’ve had a lot of announcements and briefings about peace talks since then, at least some of which appear to have been real, and it looked for a while last week as though there might actually be a chance of an interim agreement, but that has foundered for two strong reasons, firstly that both sides badly wanted a deal they could present as an unambiguous victory for themselves, and secondly that Israel didn’t want any peace agreement, and weren’t willing to restrict their actions in any way to get such any agreement.

On Saturday 23rd May, after a week of talk about active hostilities resuming, as the Polymarket odds of the Strait of Hormuz opening by the end of June fell to 25%, there were announcement that a peace agreement was close, and over the coming week those odds rose and peaked at 59%, and oil fell over 15%. By yesterday morning those odds had fallen back into the 20s and at the time of writing are at 22%. At the high yesterday oil had rallied back 50% of last week’s decline.

Announcements I saw from Iran yesterday included them leaving the negotiations because Israel were not allowing a ceasefire in Lebanon, or observing the ceasefire in Gaza, then Iran cutting off all diplomatic communications with the US, and saying that they were also about to close the Bab al-Mandab Strait for the first time in this conflict. It appears that peace talks have collapsed and will not be easy to resume.

So what now?

Well as I was saying in my post on 23rd April, the main issue was always whether the Strait of Hormuz stayed closed, and traffic through the Strait has now been at very low levels for over three months.

The consensus view is that oil supply is currently falling short of demand by about 6 million barrels per day, and that has been the case for over three months now. In that time global working and reserve stocks of oil have been declining and Exxon warned last week that these are reaching critical levels, and that within two or three weeks we might see a supply crunch that could see oil prices hit the $150 to $160 area. Chevron agreed and said that June and July would be very difficult months for oil markets.

It is likely that a major supply crunch on oil is coming in June or latest in July and prices would then need to reach a level where enough demand was destroyed to balance demand with this restricted supply. That might of course require prices going a lot higher than $150, and staying there potentially for months.

So what are the charts telling us?

The Brent Crude and Light Crude oil charts are telling similar stories here so I’ll just be looking at the Light Crude (WTIC) charts today.

On the bigger picture WTIC broke up from a falling wedge in February, and from a double bottom at the beginning of March. That made target within a couple of days. That falling wedge was also a decent quality bull flag and that flag has a target at a retest of the 2022 high at 126.42 which has not yet been reached.

There is also an older double bottom from before the 2022 high with an extended target at a retest of the all time high at 147.27. If Exxon and Chevron are right then both of those targets may well be hit in the next few weeks. That would involve WTIC rising $57 in that time from the level at the time of writing.

WTIC monthly chart:

On the daily chart a rough triangle has been forming from the March high and this would generally be a bullish consolidation pattern that should in due course deliver a retest of that March high at 119.48.

If we see last week’s low retested, though that isn’t the obvious scenario here, that should set up positive RSI 5 divergence and set a possible daily buy signal brewing.

WTIC daily chart:

On the hourly chart a falling megaphone from the 109.44 high formed last week and broke up on Sunday. The rally peaked almost exactly at a possible IHS neckline and there may well be an IHS forming here. If so a sustained break back up over the neckline at 94.67 would look for a target in the 103.10 area. That seems an obvious target area with my rough triangle resistance currently in the 106.8 area.

WTIC 60min chart:

Has the IHS right shoulder bottomed out? Very possibly, as there is an encouragingly high quality falling wedge that has formed on the 1min chart from yesterday’s high. If that holds then the right shoulder low is either made or close. As I have been writing this post this falling wedge has started to break up.

WTIC 1min chart:

Do I think that Brent & WTIC have a real shot at reaching Exxon’s $150 to $160 area? Well the projection I gave weeks ago in the event of a supply crunch was in the $150 to $300 range, so that would be at the low end of my range.

In the event that the Strait of Hormuz magically opened tomorrow I’m thinking we would likely see those new all time highs in any case. I understand that big oil tankers travel at a fast walking pace, so any resumed supply wouldn’t likely be important for a few weeks afterwards in any case.

The oil long from here has potential to be the trade of the year in my view.

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Four Beautiful Topping Patterns

In my post on 6th May I was looking at the resistance trendline on the SPX weekly chart and that rising trendline was being close to being hit in the 7385 to 7400 area. It was then hit and exceeded in what might have been a bearish overthrow, but I had by then also drawn in an alternate high quality resistance trendline that was hit perfectly at the high on Friday. SPX could go a bit higher, but the ideal upside trendline target has been hit. Look at the chart below and admire this beautiful rising megaphone from the 2022 low. :-)

SPX daily chart:

In my last post on Friday 14th May I was putting the case that further upside was likely to be limited, and a decent looking candidate high was made that day, with a modest decline into yesterday’s lows.

So what now?

Well, now I am looking for topping patterns, first some smaller ones for the next leg down, and after that some larger ones for the much larger retracement that I think will likely follow.

In terms of these first topping patterns I was hoping for high retests on SPX and QQQ, and we could still see those, with newsbomb potential here high with the Iran talks apparently in progress again, and NVDA earnings out after the close tonight.

I remain doubtful that there are any serious talks with Iran happening, as it is clear that previous talks were mostly imaginary, and as it is already clear that the resumption of US attacks planned for yesterday were delayed, not by talks, but by an ultimatum to the US from Gulf States that unless they first consented, any further attacks on Iran would have to be done without any support from Gulf States or US bases on their territory. Subject to that though, there are four high quality H&S patterns forming on SPX, QQQ, DIA and IWM, and they are as follows.

On SPX there is a high quality H&S forming, the ideal right shoulder high area has been reached today, and on a sustained break below 7330 would look for a target in the 7140 area.

SPX 15min chart:

On QQQ there is also a high quality H&S forming, the ideal right shoulder high area has been reached today, and on a sustained break below 694 would look for a target in the 688 area.

QQQ 15min chart:

On DIA there is also a high quality H&S forming, though in this case it can also be read as a double top that has already broken down. On a sustained break below 492 the double top target would be in the 483 area.

Read as an H&S, the ideal right shoulder high area has been reached today, and on a sustained break below 692 would look for a target in the 687 area.

DIA 15min chart:

On IWM there is also a high quality H&S forming, the ideal right shoulder high area has been reached today, and on a sustained break below 271 would look for a target in the 254 area.

IWM 15min chart:

Will these patterns play out? Well there are fixed daily sell signals on all four of these indices and the newsbomb part of the day may be over, with CL already having dropped $8.50 from the last highs on the news that the talks with Iran were ‘in the final stages’. As ever the first part of that decline happened before the news so we can at least be confident that US Administration insiders had a solid trading day.

As for NVDA? Well a classic move at or near the end of a big bull run would be to get good news that the market responded to by dropping. Well see how that goes tonight.

If markets rally much further I’d be looking for all time high retests on SPX and QQQ, and we might then see the all time high retest on DIA that I was looking for last week and didn’t see.

Either way further upside looks limited, and at most I think that this bull run from the late February low is likely to be over by the end of May.

After this equities high is made I think the months after that high lean strongly bullish for oil, food and inflation, and bearish for equities and US treasuries.

In my post on 30th April I made some predictions for oil, equity and bond markets over the rest of this year. Nothing has happened since to change this longer term view though it might take an extra month for US inflation to reach 5%.

1. Oil - I think it is now very likely that Brent Crude and West Texas Intermediate Crude will hit new all time highs over $150 within weeks, and that we may well see prices in the $200 to $250 range within months. Gas at the US pump will likely rise into the $6 to $9 range and oil will likely be over $100 on a monthly average basis for the rest of this year.

2. Bonds - US Inflation will likely go back over 5% within two months and may go over 7% by the end of the year. Ten year and thirty year Treasury yields will likely go over a key psychological level at 6% over the summer and may reach 9% before the next big high on yields is made.

3. Equities - Looking at SPX I’ll be looking for at least a decline into the rising support trendline from the October 2022 low, currently in the 5400 area. On a break below I would be looking for a retest of the April 2025 low at 4835.04.

Obviously this is a bearish take, but I have not felt this bearish about equities since summer 2008 and February 2020. There is good reason to be bearish here.

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