Crude Is Due for a Pullback

Crude oil futures on the New York Mercantile Exchange on Friday pushed to yet another all-time record high above $127 a barrel. Overall bullish fundamental supply and demand factors have combined with a bullish technical picture that continues to invite speculators to jump in on the long side of crude oil futures contracts.

News early Friday that Goldman Sachs had issued a fresh report predicting crude oil prices will average $141 a barrel during the second half of 2008 also encouraged fresh speculative buying interest in crude oil futures.

Indeed, shorter-term and longer-term price trends in crude oil futures continue to be up. Most professional traders agree that price trend is the most important element of being on the right side of trading any market. The venerable market adage -- "The trend is your friend" -- is working solidly in the favor of crude oil bulls.

However, technical signals from the past week now suggest that crude oil futures are due for a significant downside price "correction" in the very near term.

Veteran market watchers know that even the strongest bull market moves do not see prices move straight up, instead coming in a series of thrusts higher, interspersed with corrective pullbacks in which prices temporarily decline.

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Source: Futuresource and TradingEducation.com

The relative strength index (RSI) technical indicator overlaid on the daily bar chart for June Nymex crude oil futures shows that this week's price action produced an RSI reading above 70, which indicates a market is short-term overbought and due for a downside correction very soon.

The past four times the RSI has moved above 70 -- dating back to November -- the June crude oil futures have experienced a temporary price decline that ranged from $6 to $13 a barrel before resuming the overall price uptrend.

Dollar Still Driving

The lower value of the U.S. dollar vs. the other major currencies over the past several months is given much credit for the record-setting run in crude oil futures. As the value of the greenback has declined, speculators around the globe have used their own currencies to snap up the cheaper U.S.-dollar-denominated Nymex crude oil futures contracts.

While the dollar has seen a tepid recovery against its major counterparts in recent weeks, as seen by the U.S. dollar index, the American currency is still in a longer-term technically weak posture that still favors speculative crude oil bulls.

If the U.S. dollar does start to show some sustained upside power, though, that would very likely coincide with the crude oil futures market topping out, possibly sending prices back below $100 a barrel. An important technical price level to monitor in the U.S. dollar index is the 75 level. A push above that longer-term chart resistance level would be technically bullish for the dollar index and would suggest that the index could trend still higher.

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Jim Wyckoff is a senior market analyst for TradingEducation.com a free educational Web site. In addition, Wyckoff writes a blog offering current market commentaries every morning on TraderBlogs.com. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Wyckoff appreciates your feedback; click here to send him an email.