Crude Oil Market Structure – Extremes in Speculative Net Long Positions

On May 28, markets were closed so this Report is coming out a day later than normal. The price of gold rose nine bucks, and the price of silver 4 pennies. With little action here, we thought we would write 1,000 words’ worth about oil. Here is a chart showing oil prices and open interest in crude oil futures.

 

WTIC (West Texas Intermediate crude) price and futures open interest – the vast increase in OI was largely the result of a breathtaking surge in speculative buying. [PT]

 

We don’t track the oil basis (perhaps we should). However, as we have discussed in the past, open interest rises in response to a rising basis. That is, when speculators bid up the price of futures relative to the price of spot, it becomes more profitable to carry the item concerned. Unlike gold, oil has a significant cost to carry (it has to be stored, it is flammable and toxic, it can spoil with too much sun or oxygen, etc.).

However, the same thing is true for oil as for gold. A positive and rising basis attracts the marginal warehouseman (tanksman?) to buy spot and sell futures against it so as to profit from the basis.

Open interest was around 1.6 million contracts when oil was making its price low. Since then, the price has nearly tripled (not counting the price drop last week). At the same time, open interest has increased by nearly two thirds. We would wager an ounce of fine gold against a torn dollar bill that there has been a commensurate rise in the basis.

 

Commitments of traders in NYMEX crude oil futures – recently large speculators held the largest net long position in crude futures ever recorded, exceeding even the extremes seen in 2014 by a sizable margin. This is not bearish per se, but it does represent a huge amount of potential selling pressure that is likely to emerge with a vengeance at some point. Whether the most recent decline is meaningful or only another short term correction remains to be seen, but given this large market imbalance caution is definitely advisable. Speculators actually enjoy a minor gain upon rolling their futures over at the moment, as the market is slightly in backwardation (it is very little in the nearer months, with the discount steepening noticeably in futures that are a year or further out – however, most of the open interest and trading volume is of course concentrated in the nearest expiration cycles). The  flood of speculative buying in the near months was egged on by declining inventories, but as we have seen in 2014 – 2015, once the curve begins to flatten and threatens to go back into contango (which as a rule will tend to coincide with a reversal of the trend in inventories), speculators will turn on a dime and with their net long positions this large, their selling can quickly become relentless. [PT]

 

A price that has risen due to and along with a rise in the basis is not going to remain high. All that quantity of the good has gone into warehouses (tanks). When the marginal demand for warehousing (tanking) turns off and becomes instead the marginal supply, watch out.

We have no idea if this is the week for it, but it fits with the dramatic drop in interest rates. From May 18 to May 25, the 10-year Treasury yield fell from 3.11% to 2.93%. That may not sound like a lot, but in percentage terms the move is 5.8%. We have no idea if this is the decisive turn down interest rates, or if there is more upside action before that turn occurs. But we do know two things.

One, the long-term trend is still falling interest rates. Two, commodity prices correlate with (and are caused by) moves in interest rates. Rising rates cause rising prices, and falling rates cause falling prices for reasons spelled out in my Theory of Interest and Prices.

 

Fundamental Developments in Precious Metals

We will take a look at the fundamentals, not of oil, but of gold and silver. But first, here is the chart of the prices of gold and silver.

 

Gold and silver priced in USD

 

Next, this is a graph of the gold price measured in silver, otherwise known as the gold to silver ratio (see here for an explanation of bid and offer prices for the ratio). It rose a skosh this week.

 

Gold-silver ratio, bid and offer

 

Here is the gold graph showing gold basis, co-basis and the price of the dollar in terms of gold price.

 

Gold basis, co-basis and the USD priced in milligrams of gold

 

The price of gold rose this week, but its scarcity fell. The Monetary Metals Gold Fundamental Price fell $24 this week to $1,398.

Now let’s look at silver.

 

Silver basis, co-basis and the USD priced in grams of silver

 

The same thing happened in silver, except the drop in scarcity was larger than in  gold. And the price fell accordingly. The Monetary Metals Silver Fundamental Price fell 49 cents to $17.43.

 

© 2018 Monetary Metals

 

Charts by: SentimenTrader, Monetary Metals

 

Chart and image captions by PT

 

Dr. Keith Weiner is the president of the Gold Standard Institute USA, and CEO of Monetary Metals. Keith is a leading authority in the areas of gold, money, and credit and has made important contributions to the development of trading techniques founded upon the analysis of bid-ask spreads. Keith is a sought after speaker and regularly writes on economics. He is an Objectivist, and has his PhD from the New Austrian School of Economics. He lives with his wife near Phoenix, Arizona.

 

 

 

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6 Responses to “Wild Speculation in Crude Oil – Precious Metals Supply and Demand”

  • RandianZealot:

    “Open interest was around 1.6 million contracts when oil was making its price low. Since then, the price has nearly tripled (not counting the price drop last week). At the same time, open interest has increased by nearly two thirds. We would wager an ounce of fine gold against a torn dollar bill that there has been a commensurate rise in the basis.”

    The author of this article would lose that wager. The oil basis has contracted, not expanded. The spread between 3-year and spot prices is now LOWER than it was when the price move began. This is always what happens when inventories decline, as Stefan Weiler has stated,

    “it is important to highlight the strong inverse relationship between inventories and time-spreads. A commodity price curve tends to trade in contango when inventories are high and in backwardation2 when inventories are low (see Exhibit 2).” https://www.goldmoney.com/research/goldmoney-insights/crude-oil-the-next-5-years

    Keith Weiner writes a lot of great research, and I usually enjoy what he writes. But unfortunately, he doesn’t understand what determines the shape of a commodity futures curve.

    He also doesn’t understand how a currency futures curve is determined, but that’s a story for another day.

    • 3 years? There was a price collapse and a V bottom back to the 40’s, where it resided for awhile. There was no place to put the supplies, as oil in storage nearly doubled from long term inventory levels. I believe Keith was speaking of a more normal market, not one where producers were often selling below cost.

      • RandianZealot:

        Keith said “We would wager an ounce of fine gold against a torn dollar bill that there has been a commensurate rise in the basis.” There has not been. The basis has fallen, not risen, as the price has gone up.

        There’s nothing unusual about this market either. In most cases, the basis falls as the price goes up. Look at this chart, for example: https://www.rcmalternatives.com/wp-content/uploads/2013/07/Crude-Oil-Backwardation.png?x29499

        In this chart, the red line represents longer-term oil futures SUBTRACTED FROM shorter-term ones. The higher the red line goes, the more backwardation (or less contango) there is. In other words, the red line is the oil basis inverted.

        As you can see, the big move up in price from 2007-2008 coincided with a falling basis (increased backwardation) while the move down in 2009-2010 coincided with a falling basis (increased contango). At the same time, open-interest increased during the spot-price-rise and decreased during the spot-price fall, as can be seen from this chart: https://media.dailyfx.com/illustrations/2017/02/06/COT-Crude-Oil-New-Week-and-New-Record_body_cad.png.full.png

        In other words, the oil market did exactly the opposite of what Keith’s basis theory predicts.

        Keith’s gold-leasing business has the potential to change the world. We’re all fortunate that he gets most things right. But he’s wrong about this one.

        • RandianZealot:

          When I typed “the move down in 2009-2010 coincided with a falling basis (increased contango),” I meant to type “the move down in 2009-2010 coincided with a rising basis (increased contango).” I’m not sure how to edit comments on here.

        • Keith Weiner:

          Tom,

          You are right. Pater emailed me after the article last week. I wrote more about it int he Report this week.

          Thanks.

          • RandianZealot:

            Your welcome. I just read your new post and saw where you realized the mistake. I didn’t realize you had addressed this in your new post.

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