Crude Oil and Ed Yardeni:
A Technical Perspective

by, Barclay T. Leib

December 8, 1999

There is one cardinal tenet that all people who believe in Elliott Wave analysis espouse: impulsive moves in the direction of the trend must trace out a clear "five wave" pattern before they are complete. Waves one, three, and five are always in the direction of the trend, and on a smaller scale also must subdivide in a five-wave fashion. Wave two, and four are corrective affairs that have less structure.

Before one's eyes glaze over, and looking at a current crude oil chart, the advance from the Oct 11 low cannot be counted as a completed five waves. Ergo, although crude oil declined Tuesday and may do so for the next few days, new highs for crude must eventually still be in the offing.

No, this is not tealeaf reading. This is a microanalysis of market behavior that is becoming more mainstream by the day. While some traditionalists on Wall Street continue to espouse and defend Burton Malkiel's famous "Random Walk Theory" and "Efficient Market Hypothesis," an increasing number of traders and researchers alike believe that markets somehow behave in a fractal fashion. Fractal is a buzzword from the realm of chaos theory meaning that similar forms repeat at different scales.

A Long History

Elliott Wave analysis was first popularized by financial writer R.N. Elliott in the 1930's as he re-examined the chart patterns in the equity market leading up to the Crash of 1929. Several analysts further expanded the market analysis technique over the years, including Robert Prechter, a Yale psychology major, who started writing Elliott Wave commentary in 1976.

The October 1993 Economist magazine, examining the latest developments in financial theory, acknowledged that markets were probably not random, and that a definite order was visible on most charts. Later, The Journal of Physics in a 1996 study of stock market price patterns, said that "the log-periodic structures documented here bear some similarity with the 'Elliott waves' of technical analysis."

Most recently, Prechter, also an author of several texts on Elliott analysis, published a new book called Socionomics in which he examines fractal patterns both within markets and within society as a whole. Although Socionomics is not exactly light reading, Prechter's book has been well received by many in the academic community.

January Crude

So it is that we turn to the current picture of January crude oil. While on one scale this market could well be within a final fifth wave advance of the overall move that began back on February 16, 1999, there is absolutely no way that any sane individual can count a smaller-degree five wave advance from the Oct 11 low. The fractal pattern of completion that any good Elliott-oriented technician would look for is simply not there.

Instead, the high left Nov 22 at $27.15 is likely to be the end of a third wave, and probably just a minor third wave of the final 5th wave advance. This implies at least one more new high to follow, and more probably two more new highs if one examines the wave structure closely. Crude prices above $30 may still be in the cards.

Of course such an advance is unlikely to happen overnight. Indeed, Elliott analysis would first suggest a continued period of consolidation between the Oct 25 high at $23.77 and the Nov 22 $27.15 high. This would be a less impulsive period of sloppy sideways trading that would represent a fourth wave base before upside fireworks early next year.

A Natural Stop-Loss Level

One other rule of Elliott analysis is that a fourth wave period of correcting prices cannot intersect with a prior first wave advance of the same degree. If one examines the January crude chart, the Oct 25 high at $23.77 marked the end of our most recent first wave advance. So while January crude could migrate toward this level, it should not intersect it. $23.77 would be a natural stop-loss level on a long crude position taken by an Elliott-inclined trader.

Unless we start to see such an overlap, "this still looks like a powerful and bullish pattern," states Drew Baptiste, technical analyst for Morgan Stanley New York. I have an extrapolated target of $28.50 for crude to reach before this wave pattern is likely to complete. This is the top of the weekly channel."

Yardeni and Y2K

What economic development could come along to drive this bullish Elliott wave picture to fruition?

Ed Yardeni, Deutsche Bank New York's chief economist, issued an updated Y2K report last week. Despite initial headlines that he had turned longer-term bullish the U.S. equity market, Yardeni's actual report still gave a 70% probability of a Y2K-inspired recession of some sort. Yardeni specifically stated that he still expects that "problems will occur in global just-in-time chains in manufacturing and petroleum production." On a percentage basis, he assigned the following probabilities in Y2K scenarios:

Now this is not exactly the type of analysis that befits a headline "Deutsche Bank's Yardeni Now Upbeat on Year 2000 Bug." Nor is it the type of analysis that Wall Street cares to pay any close attention to in the current frothy equity environment.

But if Yardeni's petroleum production and just-in-time glitches come to pass, this could easily be the catalyst to keep crude oil rallying to the upside. It could also serve to fulfill Elliotticians in their current crude analysis.

Yardeni Not Alone

Yardeni's views are indeed shared by several prominent money managers who see some risk in the delivery of petroleum and natural gas products to market.

One New Jersey-based hedge fund manager explained to the author recently that "There is no guarantee that many of the pipeline flow meters coming into Europe from the Soviet bloc will function properly. These pipelines are mostly underground, and are simply inaccessible. If they shut down, then Europe could experience significant supply disruptions." This individual has actually toured some of the European pipeline facilities.

Another New York-based fund manager stated "I think it would be na´ve not to expect some problems, particularly in the transportation and petroleum sectors, and especially in the less-developed nations. The Fed and all the central bankers will ensure that there is no disruption in the supply of money, but what occurs in the physical infrastructure arena could be quite another matter."

Trading Opportunity

What all of this implies, of course, is that any further near term weakness toward the $23.77 level basis January -- but not through it -- would provide a low risk-reward proposition to buy crude oil with a tight stop loss.

While Yardeni's Nov 30 missive did soften his overall tone on Y2K, reducing his estimate for a "severe" Y2K recession from 40% to just 35% -- Yardeni remains anything but a Y2K optimist. Somehow the media spin-masters may have succeeded in casting a mild moderation in his bearish view into a bullish light, but Wall Street's blithe stride into year-end would seem misplaced.

Until and unless $23.77 basis January crude is broken, or until the market has made a clear five-wave advance to new highs, the technical work of most Elliott-wave analysts and the economic work of Ed Yardeni -- admittedly so very different from each other in approach -- would appear very much aligned in their implications. The fractal pattern of ever-higher crude prices is unlikely to be complete.

Barclay Leib is an analyst, trader, and freelance writer who has worked with Fibonacci techniques for over eighteen years. He has sucessfully applied his analysis to trading positions at several different institutions including JP Morgan, J Aron Goldman Sachs, Barclays Bank, and Societe Generale. Mr. Leib has been published by Derivatives Strategy Magazine, Bloomberg,, and the Princeton Economic Institute. He may be reached by e-mail at BTLEIB@AOL.COM.

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