Oil's Fall Looks Far From Done

When I was doing my technical homework on crude oil back in September, it seemed obvious the futures contract would break $100, shake out a few stops and then jump back above that magic number. To me, that would mark the first in a wave of signals that crude had finally bottomed out and was ready to march higher in a strong recovery.

If real life hadn't interrupted my bullish thesis, I'm sure we'd be looking at $110 to $120 on the contract right now and more worried about inflation than the next Great Depression. However, the credit freeze has changed everything, including the macro cycle that lifted all types of commodities off multiyear lows and into historic highs.

The commodity bull market is now clearly broken, and there's little chance we'll see the lofty price levels posted just a few months ago for the rest of our lifetimes. This is good news for consumers worldwide but bad news for the broad segments of the American growth engine tied to oil, natural gas and coal.

This wholesale destruction undermines the long-term outlook for the S&P 500 index. The index is chock-full of energy stocks that buoyed the instrument during its run-up to a multiyear high in 2007. With that support no longer in place -- and with financial components adding a second dead weight -- it might not fully recover for many years.

Crude Oil

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Source: eSignal

Crude oil rallied from $50 to $147 between January 2007 and July 2008. It then sold off hard, dropping nearly 80 points in the last four months. This is a staggering decline for many reasons. First, commodity prices tend to seesaw back and forth rather than trend ferociously. Second, the downturn showed absolutely no topping pattern.

The lack of a quiet sideways period ahead of its historic breakdown has made the instrument extremely difficult to analyze. I've observed this vertical behavior in a few broken bubbles over the years, but it's still a shock to see the long-term rally unravel in such a short period of time, with no fight by bulls to retain control.

That's why prognosticating a final low for the decline is so difficult. Downside momentum has been relentless and is picking up steam, even though the contract has already been cut in half. This intense gravity is undermining the reliability of tradable bounces at typical retracement levels.

You can see the impact of this downward pressure in September, when the contract bounced at the 50% retracement level. The upside fizzled out after just a week, with price breaking the low earlier this month. It then paused briefly at the 78.6% level, which marked final support for the weekly uptrend. Even that level has failed to attract buying interest.

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At the time of publication, Farley had no positions in the stocks mentioned, although holdings can change at any time.

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