BUY OR SELL-Does oil’s rally have further to run?
As oil hits a two-year high, is it the time to buy or sell?
November 6, 2010 1:30 by Eva Fernandes
Oil hit a two-year high above $87 a barrel on Friday, supported by the new round of U.S. economic stimulus and perceptions of an upward shift in the oil price aspirations of producer group OPEC.
Oil has now moved well above $70 to $80 range that contained trade for most of the last year, having rallied almost 7 percent this week with U.S. crude futures touching a high of $87.22 on Friday, the highest since October 2008.
So is it time to sell into the rally? Or should investors buy into the momentum in the hope of much higher prices?
Many investors are now targeting $90, saying it could be reached very quickly, given the speed of the recent rise.
They base this argument on several planks, some fundamental and the others technical, looking at price charts.
Underpinning the bullish argument is a move by the U.S. Federal Reserve on Wednesday, when it announced the purchase of around $75 billion in Treasury bonds per month through mid-2011, totalling around $600 billion. The move is meant to avert deflation and create jobs by easing long-term borrowing costs.
Traders and fund managers say this second round of quantitative easing (QE2) has boosted the appeal of commodities as an asset class and weakened the dollar, which often moves inversely to commodities priced in the U.S. currency.
The bulls have been bolstered by Saudi oil minister Ali al-Naimi, who said this week oil consumers wanted prices between $70 and “hopefully less than $90″ a barrel. Libya, another member of the Organization of the Petroleum Exporting Countries, predicted $100 oil by the end of the year.
These comments mark a change from the range of $70 to $80 that Saudi Arabia has previously called ideal.
Oil traders who look at technical charts have also supported the bulls, saying the markets are still not overbought, despite the recent rally. Oil’s relative strength index (RSI) has a reading of 66, below the overbought range which starts at 70.
Nicholas Denbow at VOC Capital Management argues QE2 is supportive for oil and commodities as it supports demand and sees prices rising further given the momentum of the market. He sees oil moving up to around $90 a barrel in the near term.
“There is essentially a rebasing of expectations going on after QE2 and it is constructive for all commodities,” he said.
“Over $90 per barrel, the oil market will have run too far for the time being, so I would see $90 as a top for a while at least. I don’t think the market is ready for $100 yet.”
A move above key resistance would point the way for a further rally towards $90 next week, a London-based trader said.
“If it closes above here, it’s a buy next week because I think the momentum will keep us going,” said Rob Montefusco of Sucden Financial, who highlighted resistance at $87.50 for U.S. crude and $88.60 for Brent.
“After QE, everyone’s getting a little bit bullish and we’ve seen quite a good wave of buying from some of the Chinese investment funds.”
Bears say oil fundamentals do not support current prices. They argue the market is well supplied, with ample unused oil production capacity among OPEC members and doubts about how much more support oil can derive from QE2.
They cite high global oil inventories — representing 61.1 days of future demand in industrialised countries, the highest since August 1998 according to the International Energy Agency.
OPEC also said this week it has more than 6 million barrels per day (bpd) of unused oil production capacity — more than enough to meet the daily needs of Japan.
OPEC has been gradually pumping more oil since 2009 in response to recovering demand and prices.
“We are circumspect about how much more price mileage oil will get from a second round of QE,” said Harry Tchilinguirian, head of commodity markets strategy at BNP Paribas.
“You need to see the dust settle post the announcement of the Fed and we may be overshooting a little. I know a couple of the banks are touting $100, but we maintain $85 average for Q4, implying that we will retrace after the Fed-driven rally.”
Standard Bank highlighted the risk that prices already reflected the impact of the U.S. stimulus and an increase in net long positions — bets that prices will rise — in U.S. crude.
“The current level of the speculative length in oil could cause oil prices to pull back very sharply despite the Fed’s QE2 programme,” said Walter de Wet, an analyst at the bank.
“We believe that commodity markets are pricing in QE2 already and commodities will not necessarily continue to rally. We need new data to support higher prices.”
Christophe Barret, global oil analyst at Credit Agricole, said the market could run up higher in the near-term but he said it should then head back down due to ample supplies.
“If you get in the way of momentum, you can get hit. So I would not be in the market right now,” Barret said.
“But we come back down,” he said. “I don’t know whether it will be in two weeks or two months but I would expect that in three months’ time, we will be back between $70 and $80.”
By Alex Lawler and Christopher Johnson
Additional reporting by Emma Farge and Dmitry Zhdannikov; Editing by Alison Birrane