Charting the Correction in Oil

This was originally published on RealMoney. It is being republished as a bonus for TheStreet.com readers.

Unless you have been living under a rock, you know that energy prices have been in a corrective mode and that the price at the gasoline pump has eased. Many analysts have speculated that energy has been in a speculative bubble and that this move is the end of the uptrend. Now that we have hurricane threats, oil has again begun to firm up. The million-dollar question is whether this move is sustainable.

The recent correction was caused in a drop in demand that was around 800,000 barrels per day year over year in the first half of 2008. That was the largest drop in demand in the past 26 years, according to the Energy Information Administration. However, the long-term demand situation that is being pushed by emerging markets has not changed.

For example, The International Energy Agency has recently revised higher expectations for global demand growth in 2009. And the bears' argument of a global glut of crude oil is totally unsupported by the facts of weekly inventory reported by the EIA.

Recently the EIA reported that crude oil inventories were in the lower half of the average range. That is very important: Considering the weak demand, there is no sign of a buildup in U.S. crude oil inventories.

I continue to remain very positive on the oil and commodity markets over the long term. The only thing that would change this view would be a worldwide economic collapse.

I will also pay particular attention to my technical indicators, since these types of corrections can last longer than expected. In fact, commodity markets often correct over 50% during their primary uptrend.

You can see from the chart below that the energy complex is testing support, and the recent drop has been led by heavy volume, which certainly represents institutional selling. The key now will be to see if oil prices and energy stocks can continue to hold above this important support level. If we see a break below that in the near future, it will likely lead to more downside testing. On the other hand, a break above the downtrend line will likely spark a sharp rebound.

Click here for larger image.

Source: TC2000