Using Continuation Charts for Price Forecasting

Author: Bruce Liegel

Sometimes it is very helpful to take a step back and take a long-term view of markets. I have found this to be very beneficial, especially when an exogenous or geo-political event occurs that causes a short-term price spike in the market.

There are 3 things that I typically look at:

1. Where was the overall long-term trend prior to the event
2. How do the fundamentals look before and after the event
3. Is the price spike (up or down) sustainable

Let's apply this analytical framework to the case of crude oil.

Prior to China’s entry into the WTO in 2001, crude oil traded in a $10 to $40-dollar range for the previous 20 years. This price range was established after the 1970’s inflation period and the Middle East’s control of the oil price when OPEC was formed. As outlined in "The Carry in the Conundrum", the last 20 years have also seen the monetization by central banks allowing a global debt binge to develop. The combination of these two factors changed how oil has traded, and has tripled the high end of the price range from $40 to $125+. Of course, there are other factors (explained in detail in "Oil: What a Fracking World") that have caused oil prices to move higher – but these two have been the BIG drivers in causing oil volatility. Too much cheap money and the urbanization of China increased demand, pushing constraints on the supply side of the energy equation.

When you look at crude oil prices (Chart 1), it is clear that the previous market range (marked by the bottom two blue lines) is much narrower and lower than the current market range (marked by the top two blue lines). In other words, there is a dynamic change in price range from 1980-2000 and from 2000-2023. Old highs from the 1980’s are now the new lows for the 2000’s, except during the short period when oil prices traded negative in March 2020. If we break this long-term chart into two distinct time frames, and argue that the new price range is $40-$125, the current price of $82 is about midway between the two. This tells me the market is signaling the supply is about right — barring a full-scale war in the Middle East. 

Chart 1: Crude Oil Continuation Chart – Crude Oil WTI

In a severe oversupplied market, we should approach the bottom range ($40), and in an extreme undersupplied market we should approach the top range ($125). In "Oil: What a Fracking World", we focused on the supply/demand dynamics and it is pretty clear we are not in an oversupplied world. But Chart 2 clearly shows that OEPC spare capacity is now getting quite burdensome.  The oil market can be quite fickle: an oversupply by just a million barrels per day can push the price much lower. This is what caused the market to fall $10 last week prior to the attack on Israel.

Chart 2: OPEC spare capacity

There has been a lot of talk about the next "commodities super cycle". I see this as very unlikely, as the price spike in 2022 will take a few years for the market to digest. When you have these types of spikes, it changes buying and investment habits which can take a few years to filter through the market. Notice from Chart 1 that the price spike in 2008 had a rebound in 2011-2012 and then traded lower for another 5 years.  I view the current rebound in price as a corrective rally, not the start of a new bull market.

Now that we have set the view from a longer-term perspective, Chart 3 breaks down the price action from the 2022 high. The current corrective rally reached the 50% retracement level — this area was also outlined in the Oil Deep Dive and last week’s market update for warnings that a correction was imminent. 

Chart 3: Crude Oil Continuation Chart — Crude Oil WTI 

The $82 dollar level indicated by the orange horizontal line is still the best support on the continuation chart and in Chart 4, the November futures contract shows good market support in the same area.

Chart 4: November Nymex Crude Oil

The short-term fundamentals outlined previously (see "Oil: What a Fracking World") would argue that the risk was to the upside heading into winter. The Israeli attack only adds more potential to how high the price goes. There were signs prior to the attack that the Saudi’s may allow more oil to flow if the price goes a lot higher — whether this is still true or not, only a few will know. 

Oil longs still make sense in the intermediate term, with the potential for prices to reach the mid 90’s prior to a potential Saudi change in oil supply policy.

Trading strategy is based on the author's views and analysis as of the date of first publication. From time to time the author's views may change due to new information or evolving market conditions. Any major updates to the author's views will be published separately in the author's weekly commentary or a new deep dive.

This content is for educational purposes only and is NOT financial advice. Before acting on any information you must consult with your financial advisor.