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Schork Oil Outlook: Oil Bulls Need to Look Beyond China

Last week spot NYMEX crude oil traded through the $90 a barrel threshold. It was the first time since the implosion of the 2008 bubble that prompt barrels traded above this key psychological level. Be that as it may, the contract finished the week at a disappointing $87.79, down 1.6% Friday-to-Friday. Moreover, the contract failed above the neckline (?$89.50) of an inverse head-and-shoulders pattern.

Therefore, the bulls now find themselves at a critical point of reference. Failure on their part to parlay the breakthrough at $90 last week signals potential exhaustion. Wall Street’s intentions are clear. Fund managers are now scrambling to bid this market higher in a last ditch effort to salvage what has been a dismal year for them. For instance, NYMEX crude oil is up 1% year-to-date (rolling contracts) while the USO oil fund is down 4.1%.

Nevertheless, Wall Street money piled into this market at the start of the month. To wit, per Friday’s CFTC report, as of last Tuesday money managers shifted their position from 13,346 shorts (a/o 30-Nov) to 15,164 longs (a/o 07-Dec) for a net swing in bearish to bullish opinion of 28,510 contracts. More importantly, in the last two weeks the back of the NYMEX forward curve, beginning in 2012, shifted to backwardation. In this light, even more Wall Street money will pile into this market should the front of the Board shift to backwardation, in order to take advantage of the positive roll-yield.

However, the bull’s go-to excuse, China, will now have to ramp-up efforts to curb consumption after an interest rate increase in October failed to curb inflation. Over the weekend we learned that wholesale prices in China jumped by a much stronger than expected 6.1% and retail prices ran up by 5.1%. In response China’s central bank upped reserve ratios by 50 bps effective December 20th and another rate increase is expected.

As noted last month in The Schork Report , Wall Street’s bullish prognosis aside, there is a strong relationship between the pace of inflation in China and the value of oil. Now with consumer inflation rising to a >2-year high, Beijing will undoubtedly step up efforts to cool consumption. As we see in today’s Chart of the Day , when inflation in China cools down so too do oil prices.

Bear in mind, borrowing costs in China peaked in July 2008… the same month NYMEX crude oil prices peaked. Bottom line, Wall Street will love owning oil in 2011. However, the might have to find another excuse other than China to justify their view.

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Stephen Schork is the Editor of The Schork Report and has more than 17 years experience in physical commodity and derivatives trading, risk systems modeling and structured commodity finance.