Pater Tenebrarum

About the Author Pater Tenebrarum

I'm an independent analyst and have been involved with financial markets for 31 years. I write economic and market analyses for independent research organizations and a European hedge fund consultancy. I'm the main author of the blog 'Acting Man', which presents articles on the markets and the economy, a mixture of commentary on current events as well as economic theory and history from an Austrian school of economics viewpoint.

Crude Oil: Sometimes Things Work as They “Should”

Hopefully readers were able to take advantage from what turned out to be two extremely well-timed recent posts on the upside potential for crude oil (admittedly the timing was just a case of luck). We recommend checking them out again if you missed them, as they are laying out the “very lonely” bullish case in detail (see: “Is Crude Oil Close to a Low?”, and “More on Crude Oil and Industrial Commodities”).

Now that crude oil has provided us with something more than just tentative signs of life (it has rallied by approx. 25% in just three trading days), we want to briefly comment on the recent action. First of all, after such a huge advance in a mere three trading days, one should expect some backing and filling, so there is probably no hurry to jump aboard the train if one has missed the recent move.

The most important thing is however the information the recent move has conveyed:

WTICWTI crude, daily – click to enlarge.

As you can see from our annotations above, there are two very positive points to be made from a technical perspective. First of all, the breakdown to a new low was firmly rejected by the market. A so-called “false breakdown” is usually a highly reliable bullish signal (just as a “false breakout” is a highly reliable bearish signal). You could say the bears overplayed their hand, and the market let them know it.

Secondly, the advance produced three daily candles that are known as “three white soldiers” in candlestick analysis. This is considered a very bullish formation. Note also the strong expansion in trading volume accompanying the three white soldier candles, identifying the move as a likely “kick-off” to a bigger rally.

Market Structure

Meanwhile, a look at the spot market and the nearest futures contracts reveals that the contango has continued to shrink. We wouldn’t be terribly surprised if backwardation were to make a comeback in the near future. For instance, the spot price and the October future are already trading at the same level, so the front month no longer sports a premium.

Crude futuresCrude oil spot price and the six nearest futures contracts: the contango keeps contracting, and spot already trades at the same price as the nearest futures contract (at the time this snapshot was taken anyway) – click to enlarge.

What to make of this development? We believe the most likely explanation is that legendary oil trader Andy Hall of the Astenbeck fund is correct when he states that the supply estimates of the EIA (Energy Information Administration) cannot be entirely correct. Yes, it is certainly true that daily additions to crude oil supply have exceeded daily demand for some time, but the size of this excess production is probably much lower than advertised.

The point is this: the market has a strong tendency to “price in” excessive supply additions by raising the price of storage, which it does by increasing the contango in the futures market. However, we now see that the contango isn’t all that high anymore and is actually shrinking somewhat, making storage of crude oil not the enticing proposition it once was. This contradicts reports of an extremely large and allegedly still growing short term suppy-demand gap.

Once again, we feel strongly reminded of the situation in late 1998/early 1999, when the financial press was full of breathless reports about “hundreds of millions of barrels floating at sea” and a world “drowning in oil”.


Has a new bull market in oil begun? We cannot be sure of that. In fact, it seems much more likely at the current juncture that what has begun is merely a retracement of the losses incurred in the bear market to date. However, such a retracement move can certainly provide profitable opportunities, given how decimated stocks in the oil sector are at present.

As we mentioned in our previous articles in the topic, an even greater trading opportunity may be offered by certain emerging markets, such as e.g. Russia. Not only are stocks in the energy sector quite depressed there, but the currency is as well. If crude oil prices merely rally back to their most recent intermediate term high in the low 60s, both the ruble and Russian oil stocks should advance quite smartly. In fact, the ruble has already reacted strongly to the recent strength in crude as you can see below:

rubleThe Russian ruble is strongly correlated with crude oil prices (note that the chart shows how many rubles one US dollar will buy, so a decline indicates ruble strength and vice versa) – click to enlarge


The “backing and filling” has evidently begun today (we wrote this post prior to the US market open), as crude oil is selling off fairly sharply in line with the US stock market. News from China’s manufacturing survey and the US ISM manufacturing survey were pretty bad, and this is undoubtedly also weighing on the mind of traders. However, this is not negating anything we said above. As far as we are concerned, it merely sets up a fairly safe (i.e., low risk) trading opportunity.

October crudeThe active October WTI crude contract, daily. Pulling back sharply, but so far it is nevertheless only an “inside day” – click to enlarge.

Again, it needs to be stressed here that the price of oil (and other commodities) is not only a function of the direct supply-demand fundamentals of the commodities concerned. One also needs to consider what Mises referred to as the “money relation” – the supply of and demand for money relative to the supply and demand for goods/commodities.

Some people are calling for $20 crude oil these days, and we have even come across lower forecasts already. As always, when a trend becomes very extended, people tend to get carried away. When crude oil approached $150 in 2008, $200 and higher calls were very popular. We now have the same situation, only in reverse.

In the context of the money relation, we can state the following: Since the year 2000, the true US money supply has nearly quadrupled. The euro area’s money supply had risen nearly 350%. China’s money supply has grown a good sight more. We could go on, but you get the drift. There is a lot more money in the economy today than there was at the turn of the century. In every major currency area, multiples of the total amount of currency created in the entire history preceding the turn of the century have been printed. To be sure, this doesn’t make extreme downside price forecasts impossible to achieve – but it does mean that it is not particularly likely they will be achieved.

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