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Where Is Oil Heading Next? Here's What To Watch

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Oil prices have rebounded a bit in recent weeks due to a confluence of factors such as the U.S. dollar's pullback and geopolitical turmoil in Yemen, but I believe that it is still too early to determine if the rebound is for real. Oil's glut continues to grow even larger and a more extensive dollar correction is not a foregone conclusion yet, but I've learned to never fight market trends - even if they move contrary to the fundamentals.

From a technical perspective, WTI crude oil is still in its $10, three month-old trading range between its $46 per barrel support and $56 resistance levels. I want to see a convincing break above or below one of these levels as a confirmation of oil's next move. WTI crude attempted to break below its $46 support level in mid-March, but was thwarted by the sudden dollar pullback after the Fed's FOMC meeting and Saudi Arabia's intervention against the Houthi rebels in Yemen.

Source: Barchart.com

Brent crude oil hasn't rebounded as much as WTI crude oil has in recent weeks, and is still trading squarely in its $15, three-month old trading range between $50 per barrel and $65. As with WTI crude oil, I want to see a decisive break above or below one of these key technical levels as a confirmation of Brent's next move. Ideally, both WTI and Brent crude oil should break above or below their respective levels at the same time for added confirmation of oil's next move. WTI's breakdown in mid-March was not confirmed by a similar technical breakdown in Brent crude oil, which may be one reason why WTI's breakdown attempt failed, creating a bear trap.

Source: Barchart.com

As always, I am watching the U.S. Dollar Index for insight into oil's next move. The dollar and oil move inversely, and technical signals given in the dollar often help to determine oil's next move. After pulling back after the mid-March FOMC meeting, the U.S. Dollar Index has recouped some of its losses. The index is now sitting above its 95.50 to 96 support zone and underneath a falling trendline. The convergence of these two technical lines may be creating a pennant pattern, which may foreshadow another directional move upon a breakout or breakdown from this pattern.

A convincing bullish breakout in the Dollar Index may lead to further gains for the dollar and weakness for oil, while a bearish breakdown may lead to further declines for the dollar and further bullish action for oil. Petr Krpata, the most accurate currency forecaster, is skeptical of the dollar's pullback and stated, “We just see the latest correction as a perfect opportunity to get into the trade again.”

Source: Barchart.com

The euro, which trades inversely with the dollar and is positively correlated with oil, may also be forming a pennant pattern. Many trading algorithms now tie the euro to oil, which has reinforced this relationship. The euro is sitting just beneath its major resistance zone between 1.10 and 1.12. A convincing breakout would likely lead to further gains for the euro and oil, while a breakdown would likely lead to further bearish action in the euro and oil. Societe Generale recently gave four reasons why the euro is likely to continue its downtrend.

Source: Barchart.com

Oil's glut continues to grow with no sign of stopping any time soon. Tuesday's American Petroleum Institute (API) report showed that U.S. crude inventories rose by a staggering 12.2 million barrels last week versus an expected increase of just 3.4 million barrels. Traders will be watching the EIA's inventory report closely on Wednesday to see if there is a similar build. Last week's EIA report showed that oil inventories reached an eighty year record-high of 471.4 million barrels.

Source: Haver Analytics

Furthermore, a nuclear deal with Iran at the end of June could unleash an additional 700,000 barrels a day by the end of 2016, adding to the global oil glut and cutting prices as much as $15 per barrel according to the EIA. While some traders see signs of optimism due to rapidly falling oil rig counts and capex, Goldman Sachs cautioned on Tuesday that production is likely to keep a lid on prices. "Prices need to stay low for longer to achieve a sufficient and sustainable slowdown in U.S. production growth."

For now, I am watching how WTI and Brent break out of their three month-old trading ranges, whether to the upside or downside. I don't attempt to predict short-term market moves; I identify key technical levels and take a reactive approach when those levels are broken. I am skeptical of the case for an immediate oil rebound due to the glut, but I follow the trend first and foremost.

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(Disclaimer: All information is provided for educational purposes only and should not be relied on for making any investment decisions. These chart analysis blog posts are simply market “play by plays” and color commentaries, not hard predictions, as the author is an agnostic on short-term market movements.)