Oil speculators have decided to add to their long positions in the last week, pushing the net position in futures to a new record high – above the 2014 peak from which crude collapsed.
As Raoul Pal detailed previously, look at the term structure of crude oil. We’ve got a fairly steep contango for a few months but then we see backwardation in the belly of the curve. So apparently, we’re not going to need storage after June or July or so it’s going to be a non-issue those tanks are going to be empty. I’m not buying that story.
So I do see a curve steepener trade that is– I actually just bought a bunch of spreads short June, long December. Just thinking that at that point there was backwardation in that segment of the curve I don’t think that’s going to stay in backwardation I think by the time June gets here we’re going to be looking at contango again.
So that’s one trade that I see the other one I’m kind of waiting for and I’m lining up quite a few dominoes here is I think that Trump is going to get tough with ISIS very quickly after entering office and I wouldn’t be surprised if there’s some kind of ultimatum, ISIS knock it off or else, and I think there’s so much hysteria right now politically there’s so many people with such polarized viewpoints that you could easily see a an overreaction, a massive upward spike in oil prices because a lot of paranoid people are convinced that Donald Trump is going to launch nuclear weapons on ISIS or something.
I don’t think that’ll actually happen. If there was a $25 up spike in oil prices from here I would look at that as a very very ripe shorting opportunity because I don’t think prices can go $25 higher and stay there because the shale revolution will be restarted, the bakken will be relaunched and those prices will come back down.
So I don’t want to bet on the up spike I’m not convinced it will happen if it does happen I’ll definitely bet on the mean reversion. Frankly that’s all I can really see at this point for trades.
So to add on about oil. Oil is interesting to me because if you remember I made a very public forecast on oil way back in 2015 I think it was, when I said look I think oil is going to fall to $30 dollars a barrel it was like at 110 at the time and luckily it got there these things don’t always work out that way but it did and the reason I had a lot of faith was twofold one the dollar was going up and I thought it would go much higher which obviously is the normal nature of oil prices so that helps that.
The other thing was speculative position in crude oil was all time high in fact if I took the trend going back from the early 80’s it was seven standard deviations above that trend and well over three standard deviations maybe four standard deviations from the trend in the last 20 years or 15 years. So, the position was huge.
If I look at it now again, I’m looking again at my Bloomberg screen as we speak it’s equal to where it was. So, it came, all the way back down, it’s got all the way back up. So, the market is wildly gigantically bullish on crude oil and that is something that starts looking like an opportunity to me on the short side.
I get what you’re saying about the price risk which is always the danger of shorting crude oil it’s always a bit of a negative gamma trade. So it makes it a bit nervous but I still think that crude oil comes lower so I’m bullish in that.
I’ve seen a similar situation with copper driven by China and a few other things where copper position is wildly extreme and so I start to think well too much reflation is priced into these things maybe there’s an interesting opportunity on the short side.
Erik: Yeah, I very much agree with that I want to be short equities here and I want to be short crude oil but I don’t dare to touch either trade from the short side right now because there’s been so much bullish hysteria in the equity market. I don’t know what’s going to happen to you know sell the inauguration. OK I’ve said sell quite a few times in the last few years and been wrong so I want to be short but– emotionally I want to, I can’t bring myself to do it because there’s just been– every time I say OK the market can’t possibly go higher than this it ends up going higher.
In the case of crude oil, I’m convinced that this rally has played out from a fundamental standpoint. It’s that hysteria risk that if it happens it’s a fantastic opportunity to go short. I would consider puts on crude oil here as a speculation that maybe they’ll go lower. But I don’t want be an outright futures here I’d rather be in puts on futures and have a very limited downside if Trump scares everybody.
If that happens – I don’t think it’s a real risk – I just think it’s hysteria and look at there’s actually been an increase in residency applications in Chile because there are people freaking out about Donald Trump so much that they want to be in the southern hemisphere for when he starts the nuclear war that’s a fact. This is hysteria and until it settles down I don’t want to be on the short side of the oil trade unless it’s using options or something protected.
Raoul: Yeah, I agree. What is interesting oil volatility has been coming lower. Look, I don’t think it’s going to get back to where it was in 2014 when it was trading below 20 but it has come down from a peak of 80, a kind of a real trading range of 50 down to 30. If it comes any lower the ability to buy options start to make sense because oil volatility can go to 80 can go to a 100 so maybe buying some puts on oil or you buy kind of out of the money calls out of the money puts If you’ve got the view that you have that there is a tail risk events of something that Trump administration will do to drive up the price of oil and that’s possible don’t forget that the economic policies is credibly pro oil in the U.S. right now with the new administration. So, it is in that economic interest to drive up the price of oil.
So yes, I can see that too. I love these kinds of puzzles. These are the kind of ones that get me up at night thinking wow, that’s interesting, you’ve got all of the reasons why the oil price should fall, all of the geopolitical reasons and business reasons why the U.S. wants a higher oil price so how does this play out what does that mean for us.