Crude Up BIG, Let Brent Tell You Why!
Brought to you by Blacklion Capital Management
NYMEX Light Sweet Crude Oil has been in a volatile downtrend since July 2014 with large price swings mostly to the downside detailed in Chart 1 below.
Chart 1 NYMEX Light Sweet Crude Oil Futures, source: CME Group NYMEX and eSignal/Interactive Data
This week the trend was interrupted when NYMEX Light Sweet Crude Oil Futures for October delivery (the front month) rose an astonishing 16% in two (2) days to settle at $45.22 this afternoon.
Sharp corrections in bear markets are normal, but this is the largest move in years and happened almost uninterrupted with no meaningful change in energy fundamentals or the global geo political scenario.
This report analyzes some underlying factors that contributed to the move and examine if there are reasons to consider if it is a trend reversal or just a volatile correction in a downtrend.
16% two-day moves in any market do not occur without a catalyst. In the case of this week’s move in crude oil the spike up appears linked to a known catalyst – Federal Reserve comments on potential actions by the Federal Open Market Committee (FOMC) with respect to short-term interest rates. Last October the catalyst was delivered by James Bullard, President and CEO of the Federal Reserve Bank of St. Louis. Mr. Bullard’s comments came during an appearance on Bloomberg Television. This week’s remarks come from New York in a less remarkable forum.
William Dudley, President and CEO of the Federal Reserve Bank of New York held a press conference on the New York regional economy Wednesday morning August 26th. Interestingly this press conference was not widely published as most speeches and/or press availability for Fed officials usually are. His comments were not disseminated until Wednesday evening when the Wall Street Journal published the transcript at 7:26pm Eastern that day.
The New York Federal Reserve is a key regional bank located in our nation’s financial center and is directly responsible for conducting open market operations wherein the Federal Reserve adjusts short-term interest rates. Mr. Dudley is a key member of the FOMC. The President of the New York Fed is a permanent member of the committee whereas other regional Fed presidents rotate on and off the FOMC. Mr. Dudley is close adviser of Janet Yellen, Chair of the Board of Governors of the Federal Reserve System.
Mr. Dudley offered the following comment during the press conference with respect to recent market volatility and the implications for the widely assumed increase in short-term rates at the FOMC’s September meeting.
We have been assessing domestic, international and financial market developments closely in terms of their implications for the U.S. economic outlook, and we will continue to do so. From my perspective, at this moment the decision to begin the normalization process at the September FOMC meeting seems less compelling to me than it was a few weeks ago.
William C. Dudley, President and CEO, Federal Reserve Bank of New York
The remarks when published were interpreted by the market as significantly reducing the possibility of raising short-term rates next month.
Commodities, especially internationally fungible commodities denominated in dollars, are motivate to rally in the short-run by forecasts of easy monetary policy and crude oil responded in Chart 2.
Chart 2 NYMEX Light Sweet Crude Oil Futures (October), Source: CME Group NYME via eSignal Interactive Data
The date and price text box in Chart 2 highlights the hour before Mr. Dudley’s remarks were released by the Wall Street Journal. When the remarks printed the downtrend was intact. Following the release of the remarks there was an almost relentless bid for crude oil into Friday’s settlement with only minor consolidation overnight.
Crude Oil Seasonal Trend
Crude oil like other commodities exhibits seasonal trends and behavior. Using Updata Analytics we can measure those seasonal trends and delineate times of seasonal strength and weakness.
Chart 3 below details the seasonality for NYMEX Light Sweet Crude Oil Futures.
Chart 3 NYMEX Crude Oil Seasonality, source: CME Group NYMEX, eSignal Interactive Data, Updata Analytics
The top pane is NYMEX Light Sweet Crude Oil Futures and the bottom pane is the 10-year weighted average seasonality of the same. It is evident from the bottom pane that each summer crude oil enters a period of seasonal weakness that extends until December. The red arrow in the bottom pane indicates the seasonal trend for the latter half of 2015 and highlights that there is seasonal weakness ahead for crude oil.
Seasonality is driven by underlying fundamentals, is repetitive, and powerful in analyzing prices. The magnitude of this week’s correction is striking against the seasonal weakness of late August.
The release of Mr. Dudley’s comments correlate to the start of the sharp correction but doesn’t explain the magnitude. The source of the magnitude of the correction is found in the Commodity Futures Trading Commission’s (CFTC) Commitment of Traders (COT) data.
The CFTC collects positions for all commodity futures and options on futures positions by classification of trader each Tuesday and publishes the data Friday afternoon. CFTC publishes the data according to three (3) classifications of traders:
- Non Reportable
Speculators include hedge funds and professional money managers that speculate on directional price moves with risk capital. These traders tend to follow trends and can sometimes reach extreme positions that can produce large moves when they are forced to reverse those positions. Analyzing these positions is valuable to glean insight to markets and how their participants are configured.
COT data is analyzed by looking at trader’s long positions that benefit from a rise in prices, short positions that benefit from a drop in prices, and their net position calculate by subtracting short positions from long positions.
Chart 4 below includes weekly NYMEX Light Sweet Crude Oil Futures data as well as the COT data for Speculators in crude oil broken down as follows:
- Long Positions in Green
- Short Positions in Red
- Net Position in Blue/Black
Chart 4 CFTC Commitment of Traders for NYMEX Light Sweet Crude Oil, source: CME Group NYMEX, eSignal, CFTC
The blue arrow in Chart 4 highlights the recent extreme short position of the speculators. This group of traders is still net long as evidenced by the bottom pane of the chart, but only once before has their short positon been greater than 200,000 and that preceded a correction in the downtrend although not the short-term magnitude of this week’s rally spurred by Mr. Dudley’s comments.
Leverage inherent in futures and options on futures turn those near record short positions into substantial losing positions when prices rise rapidly. Mr. Dudley’s comments introduced uncertainty over whether the FOMC will raise rates next month and speculators most likely prudently offset those positions adding to the rally.
The magnitude of the correction is evident in Chart 2. Additionally, the volatility as measured by the CBOE Crude Oil Volatility Index (OVX) is rapidly rising in Chart 5.
Chart 5 CBOE Crude Oil Volatility Index, source: CBOE, eSignal/Interactive Data
During the largest part of crude oil’s downtrend in late 2014 and early 2015 the OVX spent weeks above 50 and has risen above that again as crude oil has fallen and corrected sharply.
Crude Oil – Dollar Index Correlation
Previously we’ve discussed crude oil’s long-term inverse correlation to the dollar in Chart 6.
Chart 6 Crude Oil – Dollar Index Correlation, source: CME Group NYMEX, ICE, Updata Analytics
The top includes NYMEX Light Sweet Crude Oil Futures, the center pane details Dollar Index Futures from Intercontinental Exchange (ICE), and the bottom pane is the correlation between the two instruments. The correlation is -79.48, a strong inverse/negative correlation that is visually apparent comparing the top panes of Chart 5.
The right edge of the chart includes a sharp spike in crude oil and the Dollar Index. The correlation during the past 21 trading days (~1 month) has been an amazing 85 demonstrating a very strong positive correlation. The relationship between the dollar and crude oil does occasionally become positive, but only once in the past ten (10) years has it been this strong.
The strong positive correlation does not indicate whether this may be a long-term trend reversal, but contributes to the challenge of trying to trade or profit from the sharp move.
NYMX Light Sweet Crude Oil Futures experienced their sharpest rise in years during the past 48 hours. The initial catalyst for the correction was William Dudley’s comments indicating a possibility the FOMC will maintain zero interest rate policy longer. The rally was exacerbated by the near record short position of speculators and traditional correlations have broken down.