Trader’s Narrative

Last summer I showed the inflation adjusted price of crude oil - below is the updated chart:

Source: Chart of the Day

It really puts last year’s crude oil bubble into proper perspective. Not only was it about 30% more intense than the 1970’s oil shock, it towers over the other price spikes we’ve seen.

What is even more peculiar is that this bubble was entirely artificial. It was not due to any geopolitical rationale, nor was it because of a supply/demand imbalance. It was entirely concocted out of thin air by large traders.

The world economy was fragile because of excess credit and speculation. Oil was the first domino to topple and knock the others down by slowing down the economy to reveal the rot under the surface. If it wasn’t the main cause of the worldwide economic slowdown, it was definitely one of the leading reasons for its severity. Although the connection needs no explanation, you can clearly see that every single recession was either preceded by or coincided with a large increase in the price of oil.

The crazy part of all this is that no sooner had the dance ended that the same players started dancing all over again. Hedge funds and large players are once again stampeding back into crude oil and commodities. After bottoming in February 2009, crude oil has doubled in price! That’s a little over 3 months ago!

And once again, there is absolutely no rationale for such a move. What? Have we suddenly lost our previous reserves of oil? is production somehow curtailed by war? or geopolitical unrest? or perhaps the market believes that the world will suddenly consume much more oil than it did before the recession?

As a trader, we don’t really care whether there is a legitimate move or manipulated by deep pockets. But at the same time, if you’re going long and letting the trend take you for a ride, just remember the difference between turkeys that get caught up in a tornado and eagles. One comes down to earth with a thud. The other soars majestically, landing at a time and place of its choosing.

A few weeks before crude oil topped out at $147.90 in July 2008, I kept pointing out that something was just not right with that market. In “What is Really Going on With the Price of Crude Oil?” I pointed out the role of large institutional funds and a few days later I showed a graph of the inflation adjusted price of crude oil which should have put the question to rest.

Follow the above link to see the chart because I truly marvel at how anyone could have looked at that and not realized that what we were seeing was not “peak oil” but the same imbalance that any run of the mill bubble produces. The 2008 run-up dwarfed both the late 1970’s oil shock and the 1991 Persian Gulf war spike.

Since then, we’ve seen the great unwinding of that frenzy take oil down to $35 - less than a quarter of its high in 2008. But now hedge funds and large institutional traders are, once again, returning to commodities in a big way. Below is a chart of the large speculators’ net long positions according to the US Commodity Futures Trading Commission:

Source: Bloomberg

Of course this shows all 20 major commodities monitored by the CFTC. Oil is in there somewhere having recovered its 200 day moving average, and risen 85% from its low in late 2008. But the money is flowing to agricultural products, metals and softs as well.

All that it will take is for the large speculators to pile on as they did before and the commodity bull will become a self-fulfilling prophecy. While that may nip the ‘green shoots’ it may also cancel out any remaining deflationary pressures.

We’ve fallen below the lower trend line of the wedge formation. Are the bears reasserting themselves? Is this a headfake before the market continues to shock everyone by going up again?

Check out these links from this weekend’s reading list at news.tradersnarrative.com:

• Ritholtz: Financial Crisis Far From Over
• Reverse Head & Shoulders Forming?
• 3 Questions Before You Start Your Trading Day
• Get a FREE Subscription to Traders Magazine
• An Encouraging Straw in the Wind
• Soros: We averted a financial collapse
• Get Your Exclusive Invites for SkyGrid
• US Moves to Regulate OTC Derivatives
• Oil prices about to plunge again?
• The Unbearable Lightness of Nassim Taleb

Follow the link below to get much, much more:

And remember to check regularly since there are new links added everyday.

Week Ahead: Dull Market About to Get Exciting

There is an tsunami about to make landfall on the US economy. But will it be inflation or deflation? On the one hand we have deflation propelled by the crushing of commodity markets: oil, gas, gold, etc… as well as the massive real estate implosion across the globe.

On the other hand, consider all the inflationary agents:

• loose US monetary policy the discount rate (as expected) being lowered to 1%
• a loose fiscal policy (in an assumed Obama Biden administration)
• a $1 trillion financial bailout
• IMF bailouts of countries such as Iceland, Pakistan, etc.
• loose monetary policy for all major central banks of the world

To muddy the waters even more, the US dollar has shot up to 2004 levels. Most would argue that a stronger dollar is deflationary. So amid all these cross currents, what can we expect as the net result? I’m not smart enough to wade through all the econometric data so I’ll let the market do that for me.

To get an idea of what the market thinks inflation will be we can look at the difference between the 10 year nominal treasury bonds and TIPS (Treasury Inflation-Protected Securities) which pay a real rate of interest. The difference between them is the forward implied inflation:
Continue reading ‘A Tsunami Is Coming, But Is It Deflation Or Inflation?’

Here’s a review of the previous post on the energy sector:

On September 18th, 2008 I wrote that the energy sector presents a bounce opportunity. As the chart of the S&P Energy Select Sector SPDR ETF (XLE) shows, the bounce was a feeble one which failed within a few days:

But the rational for it remains. The bullish percent index for the energy sector is now the lowest for any sector in the market. The only other sector close to scraping the bottom is the industrials at 3.57%.

What is very strange is seeing the energy sector and the transports in alignment. I mentioned the oversold transportation sector earlier this morning. So what we may end up seeing is the strange case where both of them rally together.

Of course, sectors don’t just rally because they are oversold. Although it is rare, they can and have gotten down to zero. We are approaching DEFCON 2 - if the sentiment overview is anything to go by. And although it sounds absolutely crazy, now is not the time to be selling but rather coming up with a game plan to go long.

The days ahead will demonstrate for traders why being disciplined in respecting stop-losses is more valuable than having the conviction behind a position.