Crude Squeeze: Don t Chase Texas Tea

Transcription

1 Crude Squeeze: Don t Chase Texas Tea In case you haven t been near a TV or financial news outlet recently, we d like to point out that WTI has exploded higher by over 25% in the last three trading days. But is this rally durable? In tonight s Closer, we go cross-asset as well as looking at positioning data and fundamentals to get an idea whether the crude rally has legs or needs a breather near these levels. First, at right, we show intraday and daily candle charts for the front month WTI contract. While the daily chart may look extremely overbought here, we would point out that to get overbought versus its 5-DMA (which it tested today but couldn t close above), WTI would need to get up above $55.4 (one standard deviation above), which is well above the 2- DMA at $ In other words, while the move has been violent and suggests a need for pause, the technical indicators we prefer aren t showing this as a major exhaustion area. This dovetails nicely with other technical commentary we ve seen on the subject; with a clean break of a persistent downtrend and explosive, high volume price action to the upside, we can t blame technicians for getting very bullish on crude here. But we do think some more caution on crude and its derivatives (equities and credit, primarily) is warranted. The primary source of our concern is positioning. At right we show net positioning as a percentage of open interest for crude, including both WTI and Brent. To be sure, net positioning is extremely short crude relative to historical precedent, with Brent for all intents and purposes at all-time highs in short interest, and WTI at its lowest levels since 21. All else equal, this is extremely supportive of the move to the upside, but keep in mind the data was recorded as of last Wednesday and therefore doesn t capture any of the explosive upside in crude since. Copyright 215, Bespoke Investment Group, LLC. Bespoke Investment Page 1 of Front Month WTI - Last Five Days +25.5% in 3 sessions! Front Month WTI - Last 12 Months CFTC Comittment of Traders: Managed Money Positioning 25% 2% 15% 1% 5% % Crude Oil WTI Brent 5.3% -5% -2.4% Group, LLC believes all information contained in this report to be accurate, but we do not guarantee its accuracy. None of the information in this report or any opinions expressed constitutes a solicitation of the purchase or sale of any securities or commodities.

2 At right, we show the disaggregated positioning for hedgers (merchants that carry physical WTI inventory, processors that need to buy crude and producers) and for speculators (money managers). As shown, actual users of oil have steadily gotten more short crude while longs have diverged. This is a trend that s been underway since oil peaked. But in the last few weeks both bullish and bearish producers have retreated, covering shorts and stopping out of longs. We think this serves as a proxy for the market finding clearing levels, although the evidence here isn t very strong. Much more important is the massive shift in financial positioning. As shown at right, the most recent collapse in oil prices has been accompanied WTI Managed Money Shorts 2 by a huge stop out amongst longs and a massive 15 build up in short positioning to levels last seen 1 since the Spring and oil made its last short-term 5 low. When shorts are added into a falling price, the conclusion is simple: price-insensitive sellers are piling in, responding only to recent price movements and momentum. Therefore any catalyst for higher prices is hitting stops, and cleaning out the huge short position that has helped push prices down. We expect next week s Commitment of Traders report from the CFTC to show a much, much smaller oil short position after the huge short base has seen such a shocking move against it. Our concern is that those shorts are the only bid, and that covering will be short-lived. To be sure, there is a fundamental story here as well; OPEC today released a bulletin (available here) that suggests supply response from the cartel after WTI dropped below $4. That said, Saudi Arabia is still growing production aggressively, Iranian supply is likely to become available over the next several years, Iraqi supply has large potential, and countries like Venezuela are unlikely to stick to quotas to closely amidst catastrophic fiscal imbalances that need oil revenue. So while the OPEC supply dimension is a supportive one, we don t see it as decisive. Supply cuts could come, but short of large quota reductions in the next several months we don t EIA Estimated US Oil Production (' barrels/day) see OPEC as being a difference maker with 1 rhetoric. 95 Another positive is the US supply situation. At right we show weekly and monthly production estimates from the EIA. Today s monthly production assessment showed a deceleration to production of ~9.3mm barrels per day in June versus 9.5mm estimated in May. Supply response in the US is bullish for crude WTI Hedger Positioning (Contracts) WTI Producer/Merchant Longs WTI Producer/Merchant Shorts WTI Speculator Positioning (Contracts) WTI Managed Money Longs Weekly Monthly Page 2 of 9

3 Baker Hughes US Oil Rig Count WTI - Brent Spread Per Barrel ($) Moderating that bullishness from a fundamental perspective is the reality that rig counts are currently rising, albeit slowly. We would broadly expect producers that are able to continuing to expand production, with smaller or less efficient drillers not able to add rigs and reducing overall production. The data roughly fits that sorting process as the market balances at a lower average cost of production and with lower total production. While lower supply is bullish, the slight uptick in rigs suggests that there are numerous producers that are profitable at these levels, ultimately a bearish sign for oil bulls. Before we move on to the cross-asset reaction to this massive rally, there are two other factors to consider. First, the WTI rally has taken place with some narrowing of the WTI/Brent spread, as shown at right, but nothing particularly drastic. This suggests there s less imbalance WTI: Front Month - 12th Month ($) between regions in the global oil markets than there was during the previous collapse in WTI to March lows. If physical markets are able to stay in balance (as a moderate and relatively stable WTI-Brent spread would suggest) then the market could be much, much more stable than it was earlier this year. This is another -1 mark for bulls. On the bearish side, though, the shape of the WTI curve still means that oil is extremely expensive to hold over time, with a position losing over $5 per barrel in negative carry over the course of the next 12 months. That negative carry ( contango, red in the chart at left) is a strong indication that spot markets continue to be oversupplied relative to demand, for now. While the contango is less negative than it was a few days ago and much less negative than the lows from March, it s still going to cost money to hold an oil long, a condition that isn t exactly supportive of more buying at these levels. With supply starting to come off-line and talks of OPEC cuts, it s not particularly likely back months can drastically outperform front-months, so unless crude rallies significantly longs will have to pay up every month as they roll contracts forward through time. We don t consider this a good sign for oil bulls hoping to attract more buyers, but the weight of contango is starting to close somewhat. Page 3 of 9

4 S&P 15 Energy Avg Short Interest Deciles & Performance (%) Day Performance Short Interest % of Float S&P 15 by Market Cap: Avg Short Interest & Performance (%) Day Performance Short Interest % of Float 2.72 Large Cap Small Cap Mid Cap S&P 15 Energy Relative Performance /14 1/14 11/14 12/14 1/15 2/15 3/15 4/15 5/15 6/15 7/15 8/ BBG USD HY Energy OAS - All High Yield OAS vs WTI OAS (bps, Left Axis) WTI ($, Inverted, Right Axis) 25 12/31 1/23 2/13 3/9 3/3 4/21 5/12 6/3 6/24 7/16 8/6 8/27 +6% In addition to the positioning data (which makes us concerned about the durability of the rally) and the fundamentals (mixed, with the balance of risk being supportive of further crude gains here), we ve seen quite a tepid reaction from both equities and credit following the huge gains. At left, we show a decile analysis that indicates the biggest equity gains have come on shortcovering, as highly shorted stocks have bounced the most. Small caps have also bounced more, with poor liquidity and high short interest helping to drive their move higher. Across the S&P 15, there s only been 6% outperformance of Energy since the lows versus the broad market last Wednesday; that s hardly the stuff of an equity market desperate for Energy risk, expecting enduring gains. In credit, cash high yield spreads (shown belowleft as the spread between Energy-only credit and the broad market) has moved much less than might be expected given the size of the widening over the last few months. In investment grade, we noted repeatedly over the last couple of weeks in both the Fixed Income Weekly dated 8/19/15 and The Bespoke Report Friday that a bounce in WTI would be supportive of the overall index. Below we show the spreads for the top ten widest issuers in CDX IG. Once again, we emphasize that while credit spreads tightened for the most part, the move was relatively modest versus what the oil markets have done, calling in to question the rally s durability. CDX IG - Highest Spread Components (bps) Name (5Y CDS) Sector Spread (Ask) Today Transocean Inc Energy 93-9 Teck Resources Ltd Materials Freeport-McMoRan Inc Materials Weatherford International Energy Assured Guaranty Municipa Financials Nabors Industries Inc Energy Barrick Gold Corp Materials 31 5 Enbridge Inc Energy Newmont Mining Corp Materials Canadian Natural Resource Energy Page 4 of 9

5 To summarize: positioning was supportive of a move in crude like the one we ve seen, but we suspect short-covering has driven the rally more than fresh demand. Fundamentals like production and OPEC machinations are supportive, but not for drastically large gains given current levels. Equity and credit reactions have been basically weak. Finally, history is not on the side of oil bulls after large rallies like the last three days. Forward Returns Date WTI Price 3 Day Move 1 Day 3 Day 5 Day 1 Month 3 Month 1 Year 8/5/ /6/ /31/ /5/ /22/ /7/ /24/ /21/ /25/ /3/ n/a Top Ten All Days WTI Top Ten 3 Day Rallies Average Median Average Median At right we show the largest three day rallies in crude oil s history. As shown, while large rallies can be quite bullish for oil in the short -term, we see a clear pattern of underperformance over the short and medium term following large price spikes. Given our views on what the recent price action has done to positioning, we think the short-squeeze without legs is the best example here and the data broadly supports it, especially when compared to overall history. At left we show the percentage change for WTI around large rallies such as the one we ve just seen. As shown, it s on average likely to see poor performance over the subsequent several months, with losses of as much as 7% from the surge. While we don t expect that, we do not recommend investors chase the move in the commodity itself, in equities, or in credit after the current rally. Its speed and force, when combined with historical analysis, positioning data, mixed fundamentals and a relatively unimpressive cross-asset reaction suggest to us that this is a poor place to be adding to Energy exposure. Look for a pullback over the next several weeks to reconsider, but do not let the current rip in Texas Tea draw you in. The risk-reward, in our view, is poor. Top Ten WTI Three Day Rallies - Indexed to On 3rd Day of Rally High Average Low Current Days from 3rd Day of Rally Page 5 of 9

6 Bonds, stocks, and the dollar sold off today as the S&P 5 closed down 84 bps (futures off slightly more) and the VIX rose as September VIX futures rose 2. points to close at CDS index product widened, with but cash bonds performed much better, led tighter by Energy, although as discussed earlier less than we might have expected. Overnight, it s an absolute banquet of economic data covering every sector of the global economy. PMIs will get a lot of attention, especially in China, but there s also GDP releases, central bank policy decisions, and hard data from numerous sectors and countries to look forward to. US Data Recap and Overnight Preview Time Release Period Estimate Reading Last 8:3 Canada Current Account Balance (bn CAD) Q : ISM Milwaukee Aug :45 Canada BBG Nanos Economic Confidence 28-Aug : Chicago PMI Aug :3 Dallas Fed Manf. Activity Aug : Corn Crop Condition 28-Aug -- 68% 69% 16: Soybeans Crop Condition 28-Aug -- 63% 63% 19:5 Japan Capital Spending Q2 +8.8% % 2: NZ QV House Prices YoY Aug % 21: China Manufacturing PMI Aug : China Non-Manufacturing PMI Aug :3 Australia BoP Current Acct Bal (AUD, bn) Q :3 Building Approvals MoM Jul +3.% % 21:35 Japan Nikkei Manf PMI (Final) Aug :45 China Caixin Manf PMI (Final) Aug :45 China Caixin Svcs PMI Aug :3 RBA Policy Decision 1-Sep 2.% -- 2.% 1: India Nikkei PMI Manf Aug : Japan Vehicle Sales YoY Aug % 2:3 Commodity Index YoY Aug % 3:15 Spain Markit Manf PMI Aug :45 Italy Markit Manf PMI Aug :5 France Markit Manf PMI (Final) Aug :55 Germany Markit Manf PMI (Final) Aug :55 Germany Unemployment Change ('s) Aug : EZ Markit Manf PMI (Final) Aug : Italy Unemployment Rate (Prelim) Jul 12.7% % 4: Italy Quarterly Unemployment Rate Q2 12.5% % 4:3 UK Mortgage Approvals ('s) Jul :3 UK Markit Manf PMI Aug : Italy GDP QoQ (Final) Q2 +.2% % 8:3 Canada GDP MoM Jun +.2% % 8:3 Canada Quarterly GDP (QoQ SAAR) Q2-1.% % 9:3 Canada RBC Manf PMI Aug :45 Markit Manf PMI (Final) Aug : Construction Spending MoM Jul +.6% % 1: ISM Manufacturing Aug n/a Domestic Vehicle Sales (mm SAAR) Aug n/a Total Vehicle Sales (mm SAAR) Aug :1 Boston Fed President Rosengren Speaks on the Economic Outlook in NY 16:3 API US Crude Oil Inventories (mm bbls) 31-Aug Commodity Eurodollars Curves/BE Trsy Yields Equity Futs Int'l Equity FX Credit Change Today (bps) Asset Last Change S&P Russell VIX Fut TSX Year Year Year Year s1s s3s Yr BE Yr BE Sep ' Dec ' Mar ' Jun ' Gold Silver WTI Copper Nikkei Shanghai ASX Stoxx BBG USD EURUSD USDJPY EM FX CDX IG Cash IG CDX HY Cash HY Page 6 of 9

7 Closing Charts & Tweets Popular Tweets on Twitter Large cap Energy sector stocks are down an average of 39% from their respective 52-Week highs. $XLE - 9:9 Pretty big miss in Dallas Fed vs -4. forecast. - 1:31 Biggest three day rally for Crude Oil (+23.9%) since January 29. $USO - 12:1 Since our data starts in 1983, this is the 4th largest 3 day move in crude oil's history %. More analysis in The Closer tonight. - 14:33 If you shorted crude oil for the month of August, your month just fell apart. From Down 18% MTD to up 4% MTD in just 3 trading days. $USO - 16:46 Worst August for the S&P 5 since :4 1,99 1,985 1,98 1,975 1,97 1, Oil Future: Last 15 Trading Days US Dollar Index: Last 15 Trading Days The Tale of The Tape: S&P 5 vs Russell 2 (Small Caps) S&P 5 Intraday: Last 15 Trading Days Gold Front Month Future: Last 15 Trading Days Long Bond Future Intraday: Last 15 Trading Days S&P 5 Russell 2 (Small Caps) Nasdaq Composite: Last 15 Trading Days 42 S&P 15 Biggest Movers Price (%) Volume vs Historical Avg (%) Most Up Most Down Most Up Most Down MCF RGS PLL BH BIG GME -8.3 ANN CABO BAS REX BIG POL PVA 14.5 ADSK OCR MDAS CRC IPXL RGS SYNA BCEI BXLT HVT WRLD WPX 12.6 BOFI ADSK PLCM REXX HHS GME SVU SGY 12.9 LL CAL 38.1 HMSY TUES IO MDP CMG CLD 1.63 UNFI UE THOR GLF 1.4 PRXL -2.5 MYE CCE NOG 9.6 LITE INDB IPCM BBG 9.54 MYL CMTL FORR PBY 9.41 PRSC PRAA ZBRA ,166 1,165 1,164 1,163 1,162 1,161 1,16 1,159 1,158 1,157 1,156 Key ETFs (1 Day % Change) Ticker Name Change Last 6 Mos SPY S&P IJH S&P IJR S&P DIA Dow QQQ Nasdaq IWB Russell IWM Russell XLF Financials -.85 XLB Materials -.55 XLE Energy 1.3 XLI Industrials -.89 XLY Cons. Cyclical -.77 XLP Cons. Staples -.69 XLV Health Care IYZ Telecom -.63 XLK Technology -.91 XLU Utilities -1.6 GDX Gold Miners -.98 XME Metals & Mining 1.54 XRT Retail -.18 XHB Homebuilders.17 IYR US Real Estate KRE Regional Banks.91 IWD Russell 1 Value -.47 IWF Russell 1 Growth VXX VIX 3.91 AGG Total Bond Mkt -.7 TLT 2+ Yr Treasuries -.77 MUB Muni. Bonds -.7 LQD Invest. Gr. Bonds -.25 JNK High Yield Bonds.5 BKLN Senior Loan.13 GLD Gold.11 SLV Silver.5 USO Oil 6.79 UNG Natural Gas VT Total World -.64 CWI World Ex-US -.72 VEA Developed Mkts -.74 EEM Emerging Mkts.18 EZU Eurozone -.28 DXJ Japan JPY Hdg'd EWZ Brazil -2.1 FXI China EWT Taiwan.38 EWH Hong Kong -1.3 EWW Mexico.8 Page 7 of 9

8 Bespoke Market Timing Model: 8/31/15 Bearish Neutral Bullish Current Level Average S&P 5 Performance (%) Sentiment Indicator Direction vs Historical One Week Two Weeks One Month CBOE Call Volume 1.2 ## NYSE Up vs Total Volume (%) 38.6 ## Nasdaq Up vs Total Volume (%) 4.9 ## Index vs Equity PC Ratio. ## VIX 5-Day ROC (%) 13.7 ## VIX 1-Day ROC (%) ## Investors Intelligence Bullish (%) 31.6 ## Investors Intelligence Bearish (%) 22.5 ## Inv Intell. Bull Bear Spread 9.1 ## AAII Bullish (%) 32.5 ## AAII Bearish (%) 38.3 ## AAII Bull Bear Spread -5.8 ## Overall Sentiment ## Technical S&P 5 1-Day Avg. Spread (%) -.6 ## S&P 5 5-Day Avg. Spread (%) -4.8 ## S&P 5 2-Day Avg. Spread (%) -5. ## S&P 5 Monthly ROC (%) -5.8 ## S&P 5 Weekly ROC (%) 4.2 ## S&P 5 Quarterly ROC 1 (%) -6.7 ## Group 1-Day A/D Line -1. ## Group 5-Day A/D Line -6. ## S&P 5 1-Day A/D Line ## S&P 5 5-Day A/D Line ## NYSE TRIN Index 1.5 ## Overall Technical ## Fundamental/Monetary Corporate Spreads (1-Day ROC) 5. ## Corporate Spreads (5-Day ROC) 25. ## High Yield Spreads (1-Day ROC) 14. ## High Yield Spreads (5-Day ROC) 99. ## S&P 5 P/S Ratio 1.7 ## S&P 5 P/E Ratio 17.4 ## S&P 5 P/B Ratio 2.9 ## Yield Curve (5-Day ROC). ## Yield Curve (1-Day ROC) 11.1 ## Overall Fundamental ## Bottom Line ## Average S&P 5 Performance (All Days) Page 8 of 9

9 Current Level Average S&P 5 Performance (%) Sentiment Indicator Direction vs Historical One Week Two Weeks One Month CBOE Call Volume Overall Sentiment Bottom Line Average S&P 5 Performance (All Days) The Bespoke Market Timing Model is a compilation of some widely (and not so widely) followed market indicators. While most investors have one or two indicators they rely on, we all recognize that no indicator by itself is correct all of the time. With this in mind, we set out to create a series of indicators from multiple disciplines in order to see what the 'crowd' of indicators are telling us. Just as no individual is bigger than the market, we contend that no single indicator is more accurate at forecasting the market than the sum of them all. What follows below is an explanation of the various fields in our report. Indicator: Current level of the given indicator. In this example, CBOE call volume is 1.7 times CBOE put volume. Direction: Change in the indicator (positive or negative) over the last week. In this example, calls relative to puts have increased during the last week. vs Historical: This field measures the distance in standard deviations that the indicator is currently at versus its average over the last five years. In the above example, the volume of calls relative to puts is.6 standard deviations above its historical average. Indicator: Current level of the given indicator. In this example, CBOE call volume is 1.7 times CBOE put volume. Average S&P 5 Performance: This field displays the average performance of the S&P 5 following previously occasions when the indicator was at similar levels to the present. Values highlighted in green indicate the two indicators for that group which are predicting the biggest gains, while indicators highlighted in red highlight the indicators which are signaling the most negative returns going forward. Overall Scores: Averages all the indicators for a given category. In the example above, overall sentiment is.3 standard deviations from its long-term average. At similar levels in the past, the S&P 5 has gone up an average of.14% over the next week,.16% over the next two weeks, and.28% over the next month. Bottom Line: This line shows the average of all the indicators in the study. In the example above, the aggregate level of all the indicators is currently.3 standard deviations above the historical average, and based on prior experiences, the S&P 5 has gone up an average of.12% in the next week,.21% in the next two weeks, and.27% in the next month. Values highlighted in red indicate returns that underperform the S&P 5 over the entire period covered (regardless of the indicator level), while green highlights indicate that they outperformed the overall average S&P 5 performance. Average S&P 5 Performance (All Days): This line measures the average historical performance of the S&P 5 over all periods for one week, two week, and one month time frames. These levels are then compared to the average level the indicators are predicting.in the next two weeks, and.27% in the next month. Values highlighted in red indicate returns that underperform the S&P 5 over the entire period covered (regardless of the indicator level), while green highlights indicate that they outperformed the overall average S&P 5 performance. Average S&P 5 Performance (All Days): This line measures the average historical performance of the S&P 5 over all periods for one week, two week, and one month time frames. These levels are then compared to the average level the indicators are predicting. Page 9 of 9