Global demand for oil is set to rise in 2011 as the economic recovery continues to remain strong in developed nations, and emerging market economies continue to grow. In early 2011, economic data out of the United States has reassured investors that the recovery remains robust. Employment figures, in particular, continue to improve, albeit at a very modest pace, and Federal Reserve Chairman Ben Bernanke has referenced the improving labor conditions as proof that the economic recovery is continuing to gain solid traction.

Strong economic growth is also continuing in emerging market economies such as China, India, Brazil, and Russia. This consistent growth around the globe has led many investors to believe that commodity prices will continue to rise in 2011, specifically oil. One way an investor can expose his portfolio to a potential rise or fall in oil prices is to buy an exchange traded fund. In this article, we are going to conduct technical analysis of one such ETF—the Powershares DB Oil Fund (DBO).

DBO tracks the price of crude oil. Therefore, if the price of oil rises in 2011, then DBO will rise as well; conversely, if the price of oil falls in 2011, then DBO will likewise fall. Let’s take a look at a price chart.

The chart above is showing about 1 year of price data on DBO. As you can see, there was a sharp selloff in May of last year. Fundamentally, this sell off was directly related to the widespread panic that flooded financial markets in May 2010 as Greece was facing imminent sovereign default. Finally, in late May, early June, the European Central Bank and International Monetary Fund stepped in and committed bailout funds for Greece and other struggling EuroZone countries. This served to calm currency trading volatility and financial markets, and as you can see on the chart above, oil has risen nicely since its low at the end of May.

DBO has made a very nice trending move off its May lows up to its February HI’s. In fact, you can see the green circles that show very clear higher lows throughout the move, which is a classic sign of strong trending behavior. Now, however, DBO is at a major breaking point. As you can see, price is coming into the HI’s of las May up at 30. Price reached as high as 29.50 in the past few weeks before selling off lightly to the 28 level. Currently, the two price levels that are most important are the 27.50 level and the 29.50 level. These are the two prices that DBO is moving inside of.

If DBO can break above 29.50, then it has a major test of resistance at 30. If it tests support to the downside, price will find support at 27.50, 27.00, and then 26.25.

Since the global economy is set to grow in 2011, DBO will most likely retest the HI’s up at 30.00. The demand for energy in emerging markets, specifically China and India, could very well pull price above the 30.00 area during the second quarter of 2011.

Taipan wrote up a nice piece explaining how the USO ETF can have a difficult time tracking the price of crude accurately due to the contango effect.

Contango is the phenomenon that futures further out in time are more expensive than futures expiring in the current month. Contango is typical in crude because it costs money to store, ship and insure oil and those costs are built into prices over time. Sometimes contango gets extremely steep, with $10+ dollars in difference within a year’s time.

If the futures prices are more expensive from month to month, the USO fund may experience what is called a “negative roll yield.”

Here is what it looks like (this is a small example; the USO trades tens of thousands of futures contracts each month):

You have 10 contracts of crude oil in October that you can sell for $80 – you net $800.

You MUST buy $800 worth of the next month’s contracts, which are trading at $85; this means you can only afford to buy 9 contracts (balance goes into cash, which is invested in short-term Treasuries, which are essentially yielding NOTHING now).

Now let’s assume that crude rallies $10 to $95 (you own 9 contracts at $85).

You would make $90 (9 contracts x $10), where the month before you would have made $100 on the same price advance.

This does also mean that you would lose less if it dropped, but if the USO continues to go higher and higher and the contango gets more steep (which happens quite a bit) you will NOT make the returns you may expect!

While the roll doesn’t make you “lose” money necessarily, it may slow the rate at which the USO responds to movements in the long term in crude oil — this is the key to this article.

I know it’s hard to read.  I had to squeeze it into the page, so it’s a bit distorted, but focus on one element of data in particular.  The DI 15 and DI 30 scores are proprietary indicators of SelfInvestors.com that measure the amount of demand in a stock over 15 and 30 trading days. Demand is measured through price and volume so high volume moves up indicate high demand while high volume moves down indicate very low demand.  Lower volume moves are more weighted less.  Taking that into consideration I see very weak demand in shorting the price of crude oil (see ultra short crude oil ticker DTO) with DI scores of -10, 12.  Now take a look at the oil ETF showing the greatest demand.  That’s the Ultra Short Oil & Gas ETF (DUG) with DI scores of 3,3.  So, if you want a decent trade with relatively less risk, you could short oil stocks and go long on the price of crude or if you’re feeling lucky, just short oil stocks. 

You can get similar data for all oil ETFs on the home page here at Oil ETF Central

So what’s the deal?  Apparently, the restriction is for sites greater than 500 feet while the Bandon Oil site is 115 deep.  However, as the New York Times reports, permits are still being issued because the moratorium only bans new drilling, not existing projects.  There are a host of other issues that clearly indicate offshore drilling is still alive and well.  It appears the government bark is more vicious than its bite and have misled the public on this issue.

At $100/barrel, that really starts to wreak havoc on an already shaky economy, so it will be interesting if the overall market begins to price that in. 

Here’s a look at the chart

Antigovernment protests have flared up in Iran again leaving eight dead  .. expect more of that to continue in 2010.  The attempted take down of an airliner over Detroit this weekend has also rekindled terror concerns especially considering Al Qaeda gas warned of more retaliation.  Throw in more Russian threats of cutting off oil supplies to Europe and you have the ingredients for higher oil prices and fertile ground for short covering.

With crude oil resistance levels at $75 and $77 taken out, it appears likely that a retest of resistance around the $82 level is coming over the next few weeks.