I am still long oil on the basis that demand is going to rocket through H2, OPEC keeps the supply brakes on supply and hence US shale requires a sharper signal to bring back the rigs. That has started but should have further to run. Today, JPM looks at what happens if the ship currently aground in the Suez Canal breaks up and sinks:
Another interesting development of this week was the blocking of the Suez Canal.While we believe and hope the situation will get resolved shortly, there are some risks of the ship breaking. In this scenario, the canal would be blocked for an extended period of time, which could result in significant disruptions to global trade, skyrocketing shipping rates, further increase of energy commodities, and an uptick in global inflation. This risk can be hedged by buying Oil and associated equities (e.g.,energy, shipping, etc.).
…Over the past week, the Oil market exhibited unusual volatility, particularly with selloffs last Thursday and yesterday. Our view is that a significant part of this selling came from systematic investors, namely CTAs. Over the past years we have studied CTA trading strategies and the signals they employ. There are, broadly speaking, 3 factors that drive positioning of a CTA strategy: 1) asset specific momentum signals, 2) asset specific and overall portfolio volatility, and 3) asset specific stop-loss signals that can override momentum signals.
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In the case of Oil, going into the last Thursday’s selloff, momentum signals for commodities were positive. Interestingly, on Thursday only short-term momentum was breached (e.g.,20-day MA), which has relatively low weight compared with other lookbacks. In Tuesday’s selloff, another short-term signal was breached as well(e.g., 50-day MA). One should note that medium-and long-term signals (e.g.,4m,6m, 12m, 200-day MA, etc.) are all still positive and would imply that CTAs should be still heavily long Oil. However, they are not. These positions have been substantially reduced, which is in our view a positive for oil prices going forward. Why were CTAs selling, while most of the signals are still positive (i.e.,over 80% of weighted average signals based on historical regressions)? The reason is the stop-loss signal that got triggered both on Thursday (and again yesterday). Stop loss ensures that a potential turning point in asset price does not result in catastrophic losses. In our books on CTA strategies, we explained why stop losses are critical for momentum strategies, and how they don’t improve return profiles, but significantly reduce the kurtosis of returns–a critical parameter of any momentum strategy.
What happens next? Once the stop loss clears on a rolling basis–and that can happen any day now–CTAs will be still left with a largely positive signal for oil, and they will re-engage their long asset exposure. We believe that will result in an upward move in oil prices (all else equal).
S&P looks at the oil flows through Suez:
- As of yesterday, 21 crude tankers were qued outside of the canal carrying 18mb.
- The canal generally carries 5mb/d so that queue is going to grow very fast.
- 86 LNG carriers also transited the canal in Feb.
These delays should resolve pretty quickly provided the big plug doesn’t sink so the base case is probably that this is a short-term price driver for oil. There are also high inventories in Europe so that should contain any price rise.
What worries me about the oil price is this:
Oil is more volatile than the US dollar but in trend terms it’s pretty unusual for a rising DXY to meet rising oil. More reassuring is the last time we had a global recovery in 2016 they did rise together for a year or so.
It is typical of wider commodities to fall amid a strong DXY, of course, which the JPM guys above did a poor job of assessing when they unceremoniously rang the bell at the top six weeks ago by declaring a new dirt supercycle imminent.
That said, if oil really were to flame out then it would take a lot of pressure off yields and may short-circuit the DXY rally anyway.
So, I’m still nervously long oil while puking wider commodity positions.