Crude oil has managed to rebound noticeably after staging a 2.5-day sell-off that began at the end of last week. Given the corresponding rally across the equity markets, oil prices appear to have been supported first and foremost by short-side profit-taking.  Apparently, concerns about China have also eased somewhat after exports from the world’s second largest economy were better than expected last month, falling ‘just’ 5.5% year-over-year instead of 6.6% anticipated and improving from the 8.3% drop recorded in July. However, imports were very disappointing – down 13.8% year-over-year – suggesting domestic demand was significantly weaker. As far crude is concerned, China imported considerably less amount of the stuff in August compared to July: 6.3 million barrels per day, down 13% month-over-month. However, the drop in oil imports only looks this weak because inbound shipments of crude had hit a record high in July. Indeed, Chinese oil imports are nearly 10% higher year-to-date compared with the same period in 2014 – undoubtedly because of lower prices.

On the supply side of the equation, not much has changed although most of the bearish news is now out there. Reports that suggest Saudi Arabia is not planning to reduce its current production levels are thus unlikely to alter the supply picture much. Saudi is continuing to rely on the expected growth in demand for revenue growth and any supply shortages from US and other shale oil producers will be the icing on the cake.  The fact that the rig count in the US fell for the first time in several weeks is indicative of future supply reduction from this group of oil producers.

Taking everything into consideration, the effect of the supply and demand factors that have been pushing oil prices lower are diminishing fast, although that is not to say that we won’t see fresh multi-year lows for oil. It just means that, if not already there, we are getting closer to the bottom of the oil market. So, oil bears will need to proceed with extra caution from here.

From a technical point of view, crude oil’s most recent sell-off has not completely invalidated the bullish setup that had presented itself at the end of last month, but has nonetheless increased the risks of further declines in the near term. The bullish setup I am referring to was the apparent false breakdown reversal pattern below the prior 2015 lows: Brent’s brief stint below the $45 handle and WTI’s short stay beneath $42.00. A false breakout pattern clearly shows the lack of willingness from traders to commit fresh funds at extreme levels, such as those just mentioned. Typically when this pattern first forms, prices stage sharp counter-trend moves that lasts for several days before going into consolidation and then the trend reverses for good. In the case of oil, prices rallied a good 25% off their lows before both contracts lost steam around their respective 50-day moving averages last week. Oil prices have since been consolidating in wide trading ranges and appear to be on the verge of further declines in the near-term.

But as the retracements get deeper in the short term, we are potentially getting closer to the key turning points for crude oil. For WTI, there is a potential Bullish Gartley formation in the making and this harmonic price pattern projects that the bottom could be at or around $42. This level is where a couple of Fibonacci levels converge with point D of an AB=CD pattern. If US oil does find support here as the pattern suggests then we could see a significant rally in the weeks and months to come. However, if no such support is formed at or around $42, this would imply that a more significant continuation pattern is underway and WTI could easily drop to around $35.00 a barrel before potentially turning around there. The corresponding Fibonacci support area for Brent is around $46/$47 a barrel. However a closing break below the previous support at $45 for Brent would invalidate this potentially bullish technical picture.