Tuesday, February 3, 2015

Fixed Income 2/3/15 Part II - Crude

Crude Oil has a flame to it.  As I write, the March 2015 contract trades $3.00 higher at $52.60.  Four sessions ago on Thursday, January 29th the contract traded to a March 2009 low of $43.58, finishing that session marginally higher from the prior close.  That Thursday session was rather non-descript as it unfolded.  Another in a series of new multi-year lows, the contract managed a rather mild range and an even narrower opening to closing price differential.  There had been a few sessions of similar ilk in the last weeks, including one to start off last week. 

Instead of being followed by still further losses, Friday’s price action was the strongest since October 2010 with open to close gains of $3.61, leaving Thursday’s session in striking contrast to the surround sessions decline and then recovery.  The advance from last Thursday’s low and today’s high is also a bit of an outlier, having last been bested back July 2012 with a $10.70 advance.

Aggregate open interest peaked in June 2014 along with prices.  We had an interesting view back then.  Open interest came lower along with prices untill November.  Then open interest began to ratchet again higher till early January when it began to attract continued and more substantial position gains.  Today surprisingly, open interest is only about 40,000 less than June levels.  The renewed willingness of traders to accept overnight positions in this contract was a sign that opportunity was more valued than prospects for a jarring 24hr period loss was feared. 

The 14 day RSI had reached 18.09 in mid-December and with continued weak price action only fell to a low of 20.46 on mid-January on a then new low.  On Thursday’s sub $44 low, this RSI rose marginally from Wednesday at 32.91 to 33.21 indicating bullish divergence.

There were a number of consolidating periods during the falling price action from June to Thursday. I marked 13 session periods where prices had consolidated before heading again lower.  Sometimes the declining price action following the consolidation period was quick and substantial other times more mild.  A 13 session period ending last Tuesday appeared to have marked a stall before further price concessions and Wednesday’s price action appeared to follow that script.  This false break lower may have prompted a last round of marginal shorts to take positions.    

The implications for higher crude prices are too numerous to list completely, and there is not enough space here to discuss them all here.  We have been interested in the way bond prices have priced lower oil prices and wondered aloud what implications there would be to rising oil prices.  In short, we expect that some of the pricing for bonds takes into consideration a deflationary impact from lower oil prices.  Our view is that the ‘oil shock’ is not an inflation event, but odd as may appear to some, slowly rising oil prices from here could in fact be inflationary. 

To the extent lower oil prices prompted buying long-dated Treasuries, or global long rates for that matter, there is room for recovering oil price action to have dramatic and opposite effects on bond prices. 

Worker strikes may be headline news and some may believe the nature of a bullish advance based on such is fleeting.  We would rather recognize a change in momentum and given the extent of the advance over the last days, which now reached $3.00 higher today, we think some weaker shorts may be found and further price gains would follow.  Bond prices too may have found a marginal long or two on Friday or before that cannot hold positions into too much more pain, resulting in a dramatic yield jump.      

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