May 8th, 2009

What Do The Charts Say About OIL and USO

Take a look at the Oil and its corresponding etf’s, OIL or USO, to see what a “bottom” of “base” looks like and how it evolves. I last wrote about these ETF’s on February 14 in “OIL, USO, DBO: Are they Broken?” when I wrote:

“Looking at the comparison charts above, I wouldn’t be surprised to see a 100-200% increase in the OIL, USO or DBO etf’s over the next 12 months for convergence with the stocks in the oil complex.”

I’m more convinced that convergence is happening. I know it seems like a generation ago but if you think back to last summer you’d remember that we were stressing about gas prices at the pump. Oil was selling north of $145/barrel and pump prices were around $4.50/gallon. In March, 2008, analysts at Goldman Sachs, presumably with the firms blessing, was forecasting that prices could reach “in the not-too-distant future“. All the discussion revolved around whether the high prices resulted from the new booming demand of the BRIC countries or from hedge funds and speculators continually driving prices ever higher.

So much has changed since then. As the financial crises started to unfold, oil prices began to fall and just before Christmas it touched $30, off 80% from the peak:

In the above chart, the blue line (on left scale) is the price of oil and the red line (on right scale) is the price of the OIL etn. As the price rose last year, the ETN tended to over reach but came back in line as the price fell. Since the beginning of this year, the price of oil has increased while the ETN has lagged.

The divergence has been explained as being due to “contango“. “Contango” results from a step slop in futures contracts and describes a strategy of buying the underlying commodity at the current spot price and delivering it in the future at the higher futures price. The low current price resulted from the worldwide economic slowdown and financial crises and the higher futures prices results from an expectation that economic conditions will soon improve.

[One other fact worth noting is that OIL is an ETN while USO is an ETF; the difference is that an ETN is subject to the full faith and credit of its issuer, Barclays Bank while an ETF is subject to the risk of a separate trust. Both move in synch with OIL priced approximately 50% of a barrel of oil and USO at 75%.]

If economic financial conditions, in fact, do improve around the world, the price of oil may again start to increase. Furthermore, the incongruity between the oil and its related etf and etn will narrow or close in which case a bottom in the OIL etn will look like this:

The chart above includes the Price Volume distribution bars on the right indicating the shares traded at each price (and the bars at the bottom the shares traded each day with red marking down days and green up days). Note that, as the market started regaining its footing after March 9, much of the volume was from shares moving into stronger hands after previous holders dumped theirs in February. It’s interesting that there was relatively little trading above $22-23 (as contrasted with the volume below that level).

I like to converting this price information into trendlines and moving averages:

What you see here are that the near-term moving averages (60- and 90-day) are starting to turn up and cross, the resistance trendline at 21 (corresponding to the top of all the trading activity visible on the previous chart), another potential resistance trendline at about 27.50 (relating to the trading activity early in December). Above that, if the ETN crosses its 180-day and 300-day moving averages, there’s little resistance.

Clearly, this is all speculative and totally dependent on oil’s futures prices. While none of us want to have to start paying $3.50-4.50 at the pump again, given the way these charts look to be evolving (and consistent with the belief that higher inflation and further erosion in the value of the $US might be coming), OIL or USO might be something you look at for your portfolio.

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