- Crude oil takes the stairs to just below $55 per barrel.
- The elevator ride back down.
- Risk-off conditions in all commodities.
- I still expect a February or early March bottom.
- UCO on dips with tight stops.
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At the start of this year, on January 8, the price of nearby NYMEX crude oil futures rose to a high of $65.65 per barrel. The peak was just 95 cents shy of the 2019 high at $66.60. It took three months for the price of crude oil to rise from a low of $50.99 per barrel in early October to the January 8 high.
The final top in the oil market in early January came as tensions between the US and Iran reached a boiling point in Iraq. However, the situation calmed, and the price declined. The price action over the next month erased three months of gains. The oil market took the stairs higher and an elevator to the downside. After reaching a low of $49.31 per barrel during the first week of February, the price began to climb slowly again. Crude oil reached a high of $54.50 on the nearby futures contract on February 20 after making higher lows and higher highs for eleven trading sessions.
Crude oil trades a lot like the US stock market. Volatility tends to decline on rallies and increases during corrections. Daily trading ranges widen out when the price falls. While the price action was bearish at the end of February, there are reasons why the energy commodity is likely to find a bottom over the coming days or weeks. The ProShares Ultra Bloomberg Crude Oil product (NYSEARCA:UCO) and its bearish counterpart ProShares UltraShort Bloomberg Crude Oil ETF (SCO) are double leveraged products that magnify the price of NYMEX futures.
Crude oil takes the stairs to just below $55 per barrel
After reaching a low of $49.50 on the active month April NYMEX futures contract and probing below the $50 level for the first time since early 2019, the price of oil recovered.
As the daily chart shows, April WTI futures rose to a peak of $54.66 on February 20 before the Coronavirus turned the market lows. Last week, the price dropped to a lower low of $43.85 per barrel. Price momentum and relative strength indicators shifted lower and fell into oversold conditions. As crude oil took an elevator lower, daily historical volatility rose to over the 38% level. The total number of open long and short positions in the oil futures market grew from 2.11 million contracts on February 20, the day that oil hit its peak during the anemic recovery to 2.21 million contracts at the end of last week. Rising open interest and the falling price is a technical validation of bearish price action in a futures market.
The elevator ride back down
I believe that a combination of two factors has led to the most recent selloff in the crude oil futures market. The spread of the Coronavirus is a threat to the global economy. As the virus spreads, people around the world will limit travel, causing the demand for oil-based fuels to decline. However, the recent price action in oil could be overdone as the market reacts to a potential threat rather than an actual global emergency. The other possible reason for a decline in oil and other markets is the rise of Senator Bernie Sanders to a leadership position in the Democratic party going into the South Carolina primary and Super Tuesday contests. The potential for a significant shift in US policy under the Democratic Socialist could be putting pressure on markets. Like President Trump, the Senator from Vermont has an excellent political ground game and base of support. If he wins the majority of delegates over the coming days, it would be hard to stop his rise and markets could begin to suffer from a second degree "Bern."
The monthly chart shows that the NYMEX crude oil futures market is on an express elevator to challenge the late 2018 low at $42.36 per barrel. Below there, the June 2017 low at $42.05 and August 2016 bottom at $39.19 per barrel will stand as levels of technical support. The ultimate downside target is the February 2016 low of $26.05 per barrel on the monthly chart. Crude oil put in a bearish reversal on the monthly pictorial in January.
The quarterly chart illustrates that a close below $50.99 at the end of March would put in a bearish reversal on the longer-term chart. However, there are lots of trading sessions ahead before the end of the first quarter of 2020.
Risk-off conditions in all commodities
Last week markets experienced the most severe risk-off conditions since the 2008 global financial crisis. The weekly price action was on the back of Coronavirus, with a bit of "Berning" in the background.
The weekly chart of the E-Mini S&P 500 shows that the index dropped like a stone along with all of the leading stock market indices.
The US 30-Year Treasury Bond futures contract took off on the upside reaching a high of 171-18 as investors and traders sought safety in flight-to-quality assets. A host of other assets from precious and base metals to agricultural products and emerging markets to cryptocurrencies all moved lower in risk-off conditions.
I still expect a February or early March bottom
I continue to expect a low in crude oil before the end of the first quarter of this year. At its late 2019 meeting, OPEC further reduced its production cut from 1.2 to 1.7 million barrels per day. The Saudis added another 400,000 barrels pushing the amount to around 2.1 million barrels.
OPEC agreed to review its production policy in early March. The sweet spot for Brent crude oil, the benchmark for European, African, and Middle Eastern crude oil, is from $60 to $70 per barrel, according to the oil ministers at previous meetings.
With nearby May Brent futures over $10 below OPEC's desired range, it may not be a question of if they will reduce output in early March, but how much the new production quotas will be to balance the market. Saudi Arabia has been pushing the cartel to cut production, but Russia had not agreed. However, the reduction in oil revenue flows weighs heavily on the Russian government and could force the hand of its oil minister and President Vladimir Putin in early March. A significant production cut would likely cause a recovery in the price of the energy commodity, creating at least a temporary bottom over the coming weeks as March begins this week.
UCO on dips with tight stops
I would be a buyer of crude oil on price weakness with a very tight stop. I am willing to stop out repeatedly in a quest to catch an updraft in the price of the energy commodity. Attempting to catch a falling knife is a dangerous strategy, but tight stops will limit losses if the price of crude oil continues to plunge. The ProShares Ultra Bloomberg Crude Oil product and its bearish counterpart SCO are double leveraged products that magnify the price action in the NYMEX crude oil futures market. The most recent top holdings of UCO include:
Source: Yahoo Finance
UCO has net assets of $337.97 million, trades an average of over three million shares each day, and charges a 0.95% expense ratio.
The top holdings of the bearish SCO product include:
Source: Yahoo Finance
SCO has net assets of $75.35 million, trades an average of over 2.4 million shares each day, and charges the same 0.95% expense ratio. Both products hold swaps and futures contracts to create double leverage compared to the price of nearby NYMEX crude oil futures. The price of the April futures contract rose from $49.50 on February 4 to $54.66 on February 20 or 10.4%.
The chart shows that UCO appreciated from $13.43 to $16.07 per share or 19.7%, over the same period. April crude oil futures turned lower and fell to a low of $43.85 on February 27, a move of 19.8% from the February 20 peak.
Over the same period, SCO moved from $14.83 to $22.38 per share or 50.9%. UCO and SCO can be useful tools for those who do not venture into the futures arena but wish to assume price risk in crude oil. However, as leveraged instruments, UCO and SCO are not appropriate for long-term investment positions in the energy commodity.
A recovery that took the price of nearby NYMEX futures to just under the $55 per barrel level failed, sending the price of the energy commodity to lower lows. The things to watch in March will be the spread of Coronavirus, the progress of Senator Sander's quest for his party's nomination, OPEC's next output cut, and the price level at the end of the first quarter of 2020. I expect volatility to continue in the oil market throughout the rest of this year.
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This article was written by
Andy spent nearly 35 years on Wall Street, including two decades on the trading desk of Phillip Brothers, which became Salomon Brothers and ultimately part of Citigroup.Over the past two decades, he has researched, structured and executed some of the largest trades ever made, involving massive quantities of precious metals and bulk commodities.
Andy understands the market in a way many traders can’t imagine. He’s booked vessels, armored cars, and trains to transport and store a broad range of commodities. And he’s worked directly with The United Nations and the legendary trading group Phibro.
Today, Andy remains in close contact with sources around the world and his network of traders.
“I have a vast Rolodex of information in my head… so many bull and bear markets. When something happens, I don’t have to think. I just react. History does tend to repeat itself over and over.”
His friends and mentors include highly regarded energy and precious metals traders, supply line specialists and international shipping companies that give him vast insight into the market.
Andy’s writing and analysis are on many market-based websites including CQG. Andy lectures at colleges and Universities. He also contributes to Traders Magazine. He consults for companies involved in producing and consuming commodities. Andy’s first book How to Make Money with Commodities, published by McGraw-Hill was released in 2013 and has received excellent reviews. Andy held a Series 3 and Series 30 license from the National Futures Association and a collaborator and strategist with hedge funds. Andy is the commodity expert for the website about.com and blogs on his own site dynamiccommodities.com. He is a frequent contributor on Stock News- https://stocknews.com/authors/?author=andrew-hecht
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