USO Update

Events in Yemen this week seem to have run over some anticipated moves such as an oil pullback as oil moved higher on middle east risk, gold pullback as gold moved higher on the same risk as flight to safety and the broader market in which a bounce was expected a bit earlier, but again events sent futures plummeting on initial news of the start of the coalition's invasion to confront the Iranian backed Shiite militia that was closing in on the Port of Aden in Yemen, having an Iranian puppet regime on Saudi Arabia's 1100 mile border with Yemen which also gives militants in Yemen the opportunity to establish a stronghold in which they can attack or pirate shipping through the world's 4th most important choke point as nearly 4 bn barrels of oil flow through the route every day and at its narrowest point is only 18 miles wide connecting the Red Sea to the Gulf of Aden, was simply a risk the Saudis were not willing to tolerate and apparently about 10 other countries in the coalition all in the MENA region. Of course this risk is not over even though the overwhelming force brought to bare on the militants should make short work of them, it is the unexpected and unintended consequences, the unforeseen that is always the most dangerous like this turning from a proxy Saudi/Iranian proxy war to a broader Sunni/Shiite secular conflict, Iraq is the quintessential example of what arbitrary borders can cause when a Sunni minority rules over a Shiite majority in a country like Iraq. Unfortunately as much as I disdain the acts of Saddam Hussein, it takes an iron fist to keep a country like that intact and although by barbaric/brutal tactics, he kept Iraq intact for 40 years. Since his deposing Iraq has been on the verge of a failed state with sectarian strife and outside militants easily gaining a foothold in the country.

Another example is Afghanistan whereby the Taliban may have officially been removed from power, but the capital can hardly project any influence outside of Kabul itself.

And perhaps the most atrocious example of them all, the genocide in Rwanda that killed nearly 1 million minority Tutsis by the Hutu majority in just 100-days as the international community and the UN stood aside and watched it happen. In this case though this was an artificially imposed sectarian separation as Rwanda was a colony of Belgium and the Rwandans who were all one people were divided in to groups by the European colonial power. The taller, lighter skinned Rwandans who seemed to have more European features were designated as Tutsis while the darker, shorter and broader Rwandans were designated as Hutus. The Belgium authorities gave the minority Tutsis all of the important positions of power causing animosity which materialized after Belgium abandoned the colony and Hutus were left to their own devices.

My point simply being, if an imagined difference that is merely born out of appearance can be so deadly, how much more so can a real difference between two sects of Islam that have been feuding for centuries?  Thus we may not have seen the last of events in Yemen or born out of the conflict there.

As for oil, I have been expecting a pullback, a stronger base to be finished up and while I have no idea what the catalyst would be other than perhaps a reversal in the $USD, I suspect a primary trend change in oil from down to up.

 This is the long term and very strong divergent 2 hour USO (WTI Crude) chart showing a H&S top and the negative divegrence at the top should be clear as it is one of the larger divergences over the last year. At the far right and lows, a large and building positive divegrence which I initially though early on would simply lead to a sharp counter-trend rally and then a resumption of the downtrend, but the base is too big now for a simple counter trend rally and I have suspected for the last 6 weeks or so that this is a primary trend base or thereabouts to lead to an upside reversal in oil.

 The 30 min chart is not as strong of a divergence as a 2 hour chart, but it confirms the same information, distribution at the top in a H&S price pattern to the left, 3C confirmation of lower prices as 3C moves lower with price and then not only a change in price trend from down to sideways, but a large leading positive 3C divegrence/accumulation.

You can already see a "W" base or double bottom which we predicted a couple of weeks ago would happen and additionally that it would make a slightly lower low (the head fake/stop run or bear trap).

This is the area of the second low at the white trend line and confirmation of the move higher off that low on a 5 min chart, still an institutional timeframe, but more for near term trade and it has recently gone negative suggesting a pullback as the longer/stronger charts are still very positive and don't reflect that kind of distribution. Thus this is what I have suspected for this week which was delayed by the sudden onset of hostilities in Yemen by the Saudi coalition.

 The very short term intraday 1 min chart also shows confirmation of the move higher off the second base lows and a recent negative divergence suggesting out forecast of a pullback in oil is a probability.

I'm not interested in shorting oil beyond perhaps a quick options (put) trade or a swing trade with some leverage. The bigger trade here is the long position and a pullback is the kind of trade I like the most in which the market comes to us on our terms and must prove itself before we ever enter in to any position or risk, it's also giving us a better price point and less risk as well as better timing.

One scenario I can imagine that may send oil higher is the reversal of the strong $USD trend. Since the end of QE, the legacy Arbitrage correlation of dollar denominated assets has returned, it disappeared during the F_E_D's QE as anything and everything were bid up on virtually free money the F_E_D was passing through the banks which they put in to the market, but since the end, it seems the historical $USD legacy arbitrage correlation has returned. This is  when $USD denominated asset like oil, gold, silver, etc. move opposite the dollar. If the dollar gains in value oil falls, if the dollar loses value prices of oil must rise to compensate. The F_E_D needs to break $USD strength and as such, that may be what changes oil's trend.

 This is USO in green and the $USD in red, note the inverse correlation in which they move opposite each other. Also note the large volume or capitulation after a nearly -80% decline in oil at the 2008 highs which marked the end of the downtrend and note a similar volume swell now that also looks like capitulation or a mass selling event or flame out.

If the Dollar is broken by the F_E_D as I believe they have to and it has already shown signs of failing, then oil has a good chance of bouncing.

This is the daily chart of the $US Dollar Index and the strong uptrend with 3C confirmation until very recently, suggesting the Dollar lose ground as it has already had one of the sharpest pullbacks in over a year recently.

Short term I expect oil to pullback to the base area at the red trendline before heading higher. A move to new lows to run stops is a probability and also a probable excellent long entry.

My Trend Channel not only held the uptrend, but is still holding the downtrend with a stop at the $18.60 area, this should tell us when there is a real change of character and oil should reverse course on a move to the upside.

As pointed out earlier today, the pullback we have been looking for near term has begun today, I suspect we see more for the immediate near term, but after that, I think we have the chance at a beautiful, long term trend trade long oil/USO.