Every market has built in fear premium. This shows up empirically through the skew of an option chain. The idea is that two strike prices with the same expiration date that are an equal distance away from the market’s current price should have the same value, everything else being equal. We can also measure this through common sense. The skew is aligned with a market’s fear. This is what creates the fat tails on index put options as well as call options in the grains. Historically, fear in the Middle East leads to higher oil prices as the possibility for supply disruptions increases in times of uncertainty. This week, we’ll examine how oil prices affect ISIS and how this could affect the oil market as a whole.
The sugar market has been one of the few bright spots in the commodity futures. Since most commodity exposure is long only and this market has rallied between 45%-50% since bottoming in late August it has become a commodity darling. There are three primary reasons for the recent rally. Of these, only one is structural. We feel the transitory nature of the other two will conspire to bring prices back down as the #11 sugar futures tighten their link to domestic prices in the primary growing regions.
The El Nino event of 2015 is expected to become the strongest on record. Considering the impact this event is supposed to have on our southern states, it’s time to review what has happened in the past as well as what may be coming. We’ll let the National Oceanic and Atmospheric Administration (NOAA), finish our intro. From NOAA’s analysis of the 1997 event. “The winter of 1997-1998 was marked by a record breaking El Nino event and unusual extremes in parts of the country. Overall, the winter (December 1997- February 1998) was the second warmest and seventh wettest since 1895. Severe weather events included flooding in the southeast, an ice storm in the northeast, flooding in California, and tornadoes in Florida. The winter was dominated by an El Niño influenced weather pattern, with wetter than normal conditions across much of the southern third of the country and warmer than normal conditions across much of the northern two-thirds of the country. ”
The crude oil sell off has been vicious both in its depth and its speed. In fact, the market has been so negative that we last wrote about it this past June 11th. The market had provided a bit of a rally in the face a growing and overwhelmingly bearish commercial trader position which led to our headline, “Sell Crude at $65 Per Barrel.” Our primary focus is based on the Commodity Futures Trading Commission’s weekly Commitments of Traders report. We use the actions of the commercial traders to help us determine value in the commodity markets like the buying opportunity in gold that we published in Futures Magazine on august 7th. Bringing this back to crude oil, here are three charts that show the crude oil market is nearing a bottom.
We began the week with Bond market analysis for TraderPlanet. We looked at the tremendous and rapid build in the commercial trader position noting that the recent sell off may be nearing exhaustion. Based on Thursday’s reversal and ECB/IMF/Greek hope quickly deteriorating, we feel the short-term bang for the buck may be best on the long side of the market.
Tuesday, we focused on, “A Pause in the Yen’s Destruction.” We noted the rapid application of the Prime Minister and Bank of Japan’s plan to monetize their debt in a last ditch effort to reflate their economy. Like the Bond market, this market has seen tremendous and rapid commercial trader buying as the Yen fell to Y120 = $1.
Finally, we looked at the disconnect between nearby crude oil prices and current fundamentals. It’s hard to get bullish about supply cuts a year out when current inventories are the highest they’ve been in 80 years as we noted in the Energy Information Agency’s, ” Summary of Weekly Petroleum Data.”
Read – “Sell Crude Oil at $65 Per Barrel.”
The crude oil trade thus far in 2015 has been a textbook example of the way we employ commercial trader activity to the commodity markets. Commercial traders in the crude oil market were relatively nonplussed about the market’s decline through the end of 2014. Time progresses, and as the market built its base and forward demand for summer gasoline blends from refiners began to take shape, their purchases quickly dominated the playing field and pushed the market higher through spring. However, I believe the bigger story is the dramatic forward selling by the commercial drillers who clearly believe this rally will be short-lived.
We looked at the recent commercial buying in the US Dollar Index on Monday, noting that, “Even though commercial traders remain heavily net short, their recent purchases have been strong enough to shift their momentum back to the positive side.” We also looked at technical support that has been tested and held, throughout this week.
You can find the full piece featured at TraderPlanet.
Tuesday was probably our best call. Equities.com featured our crude oil analysis in, “Crude Oil Spike is a Selling Opportunity.” We stated that, “our simple take on the way these usually work is that we’ll get one more spike of some type above the recent congestion that has built up. This morning’s trade near $61 is the spike we’ve been waiting on. ”
The market peaked Wednesday around $62.50 and has quickly fallen back near $58 per barrel.
We went macro with our own piece again this week as a follow up to, “The Interest Rate Conundrum” of two weeks ago. Originally, we focused on the world’s central bankers and the recent International Monetary Fund meeting in Washington. Their primary purpose was to discuss what it would take to US and global interest rates to rise and when. Apparently, Bill Gross had the answer and the markets listened in a BIG way. Even if interest rates aren’t your topic, the swings on the charts I posted are truly dramatic.
The crude oil market is dominated by the global commercial traders. Their collective actions within the marketplace reflect the most thoroughly researched best guess consensus of future prices. We follow their actions through the Commodity Futures Exchange Commission’s (CFTC) weekly Commitment of Traders (COT) report. There are two things we’ve learned; they have better access to better information and they believe the crude oil rally above $60 per barrel is one to be sold.