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.

Outlook: Crude Oil and Industrial Commodities

Crude Oil Positioning and Sentiment

When we wrote about the possibility that a low in crude oil prices may be close last week (see “Is Crude Oil Close to a Low?” for details), we left out a few data points which we will discuss today. Just to briefly recap: the question at hand is “can prices bottom in spite of all the well-known bearish fundamentals?”.

First of all, since WTIC crude has declined below the $40 mark, it is clear that it is the region between $35 to $40 (the area between the 2009 low and the 1980 high) that is probably technically relevant (as we remarked in the conclusion last week, it may be Brent that holds 40). There is as of yet of course no direct technical evidence that a low is about to be put in, but there is at least a little bit of indirect evidence, in the form of a strong price/RSI divergence on the weekly chart (this is essentially telling us that the decline is losing momentum).


There is a strong price/RSI divergence in place now, but that is more or less the only potentially positive information on this chart. Other than that, there is no evidence yet from a technical perspective that the market may be close to a turning point – click to enlarge.

Positioning data in WTIC futures probably have to be interpreted differently from the past. We are not sure why speculative net long positioning has moved into an entire different range from that previously considered normal, but one reasonable guess is that this reflects inter-market arbitrage with Brent crude. For a long time the spread between these two oil grades has been extremely wide, and this has probably invited bets on a future contraction in the spread.

Over the past several years, the spread between Brent and WTIC has shown a tendency to expand during uptrends and contract during downtrends. Occasionally political unrest in a country that is an important supplier of Brent oil can temporarily widen the spread as well. Frankly, we don’t know why this historical trend in this spread has come into being, we only know that it has. Obviously, any long positions in WTIC futures that are offset with short positions in Brent futures are not really directional bets, but primarily bets on a contraction of the spread. It is in principle irrelevant for the holder of such a position – apart from the above mentioned historical tendency – whether oil prices go up or down.

Below is a chart of the current net position of hedgers in WTIC futures (the inverse of the net speculative position). While hedgers remain net short, their short position has now shrunk close to the level that preceded a price reversal last time around:

2-Crude oil HedgersNet position of hedgers in WTI crude oil futures  – click to enlarge.


Unfortunately, since we are only guessing about the possibility that inter-market arbitrage has influenced net speculative position sizes, we cannot call the above information unequivocally bullish or bearish. However, it may be worth noting that the small speculator net position has fluctuated around the zero line for most of this year – this is in contrast to a 40,000 contract net long position this group of traders held at the end of July 2014.

One thing is clear though: surveys and positioning data combined show a near record bearish consensus on crude oil, which was only exceeded by the readings at the 1998 and 2001 price lows:


3-Crude oil Optix

Not surprisingly, no-one loves crude oil anymore. It is interesting that the bearish consensus is actually greater than at the 2009 low (which was followed by a rally of more than 200%) – click to enlarge.

Obviously, this extreme negative sentiment is perfectly in line with the price action to date, but it is nevertheless noteworthy when sentiment becomes this extremely lopsided.

The Decline in Crude Oil’s Contango

One of the few investors who profess to be bullish on crude oil is legendary oil trader Andy Hall of the Astenbeck fund. In his latest investor letter, Hall has made a remark on the shrinking contango that is worth relating. Readers may recall that we have mentioned the flattening of the futures curve as one of the reasons for anticipating a trend change. Mr. Hall explains why this is so:

“[…] the IEA forecast is the one used by most oil analysts on Wall Street as the basis for their own forecasts. For that reason the consensus view is now extremely bearish.

The latest data from the IEA is difficult to reconcile with what has actually been happening in the oil market however. If there had been a 3.3 million bpd surplus in Q2 the contango would have exploded as oil would need to price itself to make it economic to carry in ever scarcer and therefore costlier storage. That did not happen. In fact the contrary was the case – contango narrowed for Brent and WTI and the Dubai market moved from contango into backwardation by the end of Q2. This is not suggestive of a growing crude oil surplus.”

(emphasis added)

Mr. Hall also mentions that there is a striking absence of an increase in observable inventories, which jibes with his observations about the shrinking contango. In other words, the latest IEA supply-demand estimates are quite likely erroneous. There are about 1.6 million bpd of oil that are unaccounted for when comparing actual inventories with the IEA estimate of current surplus production. This is not exactly chickenfeed.

Implications of a Potential Turn

Let us hypothetically say that Mr. Hall is correct, and that our suspicion that the the oil price is close to a fairly durable low is therefore correct as well. What would be the implications? For investors it would for instance mean that the currently widely hated emerging market currencies and stock markets would quickly turn from a “sell” into a “buy”.

Especially the Russian stock market would become interesting in this case, as it is currently offering the second opportunity over the past year to get in at a really low level. Not surprisingly, both Russian stocks and the ruble have declined sharply again along with crude oil prices. The Russian market is once again one of the two cheapest stock markets in the world (the other one is the Greek stock market). Obviously, the severely beaten down stocks of base metals producers and energy companies could at the very least be close to providing a short term trading opportunity for nimble traders. Even if all that is in the offing is a short to medium term rebound, it would probably be well worth to play it, as many of these stocks have a very high beta.

A low in crude oil would likely be accompanied by a low in the prices of other industrial commodities as well. To this it is worth noting that the current record high in the Gold/commodities ratio suggests that industrial commodities are severely underpriced. The probability that their prices will soon rise is therefore relatively high. Note that we are not saying that “the” low is going to be made if prices turn up here. We are only saying that is seems likely that “a” low is fairly close. Once prices do turn, the situation will have to be reassessed as it evolves.

4-Gold-CRB ratioThe gold-commodities ratio is at a new record high – this suggests that there is a high probability that industrial commodity prices are going to change course soon – click to enlarge.

We want to add one more observation about commodity prices in general. While it is true that market perceptions about supply and demand are the main driver of prices, they are not the only driver. One factor that needs to be kept in mind is the size of the money supply.

The more money there is in the economy, the higher the nominal prices of commodities will tend to be on average. This is why we are saying that what used to be the $10/bbl. level for the oil price in the 1970s and 1990s is probably equivalent to $35 to $40 today. In short, this level is very likely to more or less represent the lower end of the channel in which the nominal price will fluctuate over the long term.


One should keep a very close eye on commodity prices here and think a bit about the many investment and trading opportunities a trend change will offer. It may still take a while before a playable turnaround actually happens, as commodity prices usually bottom in drawn out fashion and not in the form of spike lows. However,now is the time to make a plan for this eventuality.

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