The Oil Rally Isn’t Over

This last week in crude trading brought more of the same kinds of trending factors that we’ve been seeing over the last several months – and several of the key indicators continue to overwhelmingly point crude in an upwards direction, suggesting the correction that begun on Thursday, while predictable, may not be long lasting.

First to the COT report, always the best indicator of speculative action in the markets, we saw a continued movement of contract buying into crude oil. But perhaps more importantly, the continued draw-downs of speculative short selling has made the ratios of long/shorts in the markets as deep as it’s been since March and, before that, 2013.

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It is important to note that this ratio record in March presaged a drop in April, when oil prices were jolted downwards by nearly 10 dollars before resuming their upwards trend. It is almost always the case that over-enthusiasm on either side of the futures market is a preface to a correction towards the other, a phenomenon I’ve called the ‘porthole effect’. Most traders have been expecting a correction since Monday, when oil prices spiked on NAFTA news. But there are other technical factors to look at in the market that indicate that this correction may last longer than just one day.

For example, there are several overbought indicators. Here, I’ve indicated only the RSI and Stochastics showing those interim highs being reached, and how oil was due for this correction, and almost all of the other standard oscillators are uniformly in agreement:

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However, and this should be carefully noted, there are strong indications that whatever correction the oil markets see will be short-lived, and are unlikely to amount to the $10 drop that was seen earlier in the Spring. One such indication is in the matrix of inter-market spreads on crude oil, all of which have continued to show an almost unstoppable flattening of the crude curve – normally seen most strongly in a bearish market, but one that has been seen lately in a very bullish one.

While the onset of the curve backwardation did much to ‘foretell’ the rally that oil has been experiencing when it began to blow out in earnest in mid-June of this year, its move back towards its current near flat state has been seen not necessarily as a return to bearish conditions, but as an indication that the institutional back month buying from consumer and aviation hedge programs has begun to reassert itself for the first time since before the 2014 crisis. (below a representation of the curve through a continuous 1-5 crude spread through December):

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Besides anecdotal evidence that I hear through the brokerages that this buying has been evident on their decks, it’s also easy to see that change of attitude in the long-term outlook for oil, with several dozen examples in the media of analysts, oil company CEO’s and others starting to talk seriously for the first time about $100 oil. During the last week, we continued to see these spreads come in, no matter whether crude was experiencing a tremendous up day, as on Monday when the reboot of NAFTA was announced by President Trump or on Thursday, when markets began to take back much of the week’s gains.

In short, if consumer hedging bids remain a mainstay of back month trading, not dependent upon spread speculation, there is good reason to believe that financial oil bids in the front months will return again soon.

Gasoline cracks have swooned in the last week, but more notably, heating oil cracks have continued to soar – one in response to the likely winter shortfalls in diesel and other liquids that’s begun to appear - but also, I believe, in response to a warning on natural gas stockpiles by Citibank. This analyst’s optimism was tempered by the pessimism of a recent Morgan Stanley report – and I intend to discuss the natural gas outlook more at length next week, as I want to see one more injection report besides the slightly bearish 98bcf injection on October 4th before making a judgment.