(This is an excerpt from Friday's blog for Decision Point subscribers.)
Yesterday the U.S. Oil Trust ETF (USO) switched from a Trend Model neutral status to a BUY signal. The signal change occurred when the 20-EMA crossed above the 50-EMA. Erin covered this briefly yesterday, but I thought it would be good to expand on the subject a bit more.
While our official market posture is determined solely by our mechanical models, we can still step back and take a broader view of technicals and fundamentals, and determine how much confidence we have in a given signal.
On the chart below it is fairly obvious that, prior to the riots in the Mid-East, USO was starting to roll over due to general and unspecific secular forces. (See the decline to the rising trend line and the weakening PMO.) Even the short rally resulting from the Mid-East riots failed to disrupt the underlying weakness. A new low was made this month and the rising trend line was penetrated to a significant degree.
Then came a huge price jump caused by the escalation of problems in Libya, which produces three percent of the world's oil. It was this move that generated the buy signal.
Now let's zoom back and look at the weekly chart. First note the parabolic price rise in 2007 and 2008, followed by the total price collapse. Out of that collapse USO has begun what is called a basing pattern, which is very typical of what can happen after a collapse. These basing patterns can last for years, and I think it is a bit early to say that this one is about to end.
Bottom Line: Secular forces have kept USO contained in a long-term trading range, and prices were drifting down within that range before the Libyan situation provided a short-term disruption of the flow. I think that some further dire developments (not at all out of the question, of course) will be required to effect a long-term change in direction in the price of USO.
Trading ranges, as a rule, generate whipsaw signals, and that has been the case for this one. My guess is that the current buy signal will result in one more whipsaw. The top of the trading range represents our maximum expectation for this rally.
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