- WTI crude oil has seen a great deal of noncommercial selling over the past number of weeks, enough to drive the spot-month contract from a high near $95 to a low near $81.
- Additional pressure has come from commercial traders, evidenced by the spot-spread seeing its $2 backwardation at the end of September erased by early November.
- Much of the pressure is seasonal, meaning investment money could return to the market once winter lows start to be established.
The recent selloff in crude oil, both Brent crude ((QAF24) and WTI (CLZ23), has generated a lot of chatter in the media, social and mainstream. The debate is if the market, and here I’ll focus on US domestic WTI, has turned bearish. Tuesday evening I saw some conversation that the spot-month futures contract had dropped below its 200-day moving average for the first time since July 24. There are those who make the argument that algorithms watch these moving averages, and if so we would expect increased selling when they are crossed. A look at Wednesday’s activity could strengthen that argument given the spot-month contract has dropped another $1.90 from Tuesday’s close on trade volume already in excess of 222,000 contracts. During Tuesday’s plunge, when the spot-month contract lost as much as $3.73 before closing $3.45 lower for the day, trade volume was reportedly 396,300 contracts.
Given the degree of the price break in the market, nearly $4.00 from Tuesday to Tuesday alone, we can assume noncommercial traders continued to liquidate some of their net-long futures position. Last Friday’s CFTC Commitments of Traders report (legacy, futures only) showed this group holding a net-long futures position of 262,258 contracts as of Tuesday, October 31. This was a decrease of 38,507 contracts, consisting of a decrease in long futures by 12,748 contracts and an increase in short futures of 25,759 contracts. The fact most of the activity was adding shorts is more bearish than if the change had been by long liquidation. The bottom line is funds are sensing a shift in supply and demand, a key factor when deciding where to park investment money long-term.
The fundamental picture is far less bullish than it was a couple months ago. At the close of business on September 27 the spot futures spread showed a backwardation (inverse) of $2.00. This was the strongest the spot spread had been since a close of $2.04 on July 14, 2017. Since then, though, the spot spread has been free falling (cue the Tom Petty song), testing par as I type this paragraph Wednesday morning. The last time the spot-spread closed in contango (carry) was November 23, 2020, almost 3 years to the day. What makes the drop in the spot spread more dramatic is it comes at a time when Saudi Arabia announced it was extending its 1 million barrel per day production cuts through December.
But the market is bigger than the headlines. Traders, both commercial and noncommercial, have already factored in all the news, known and unknown to the rest of us. This is the basic premise of technical analysis: Market action discounts everything[i]. All we have to do is pay attention to trends (price direction over time) of basis (where available), futures spreads, and futures markets.
Is WTI bearish? From a technical point of view I could make the case the market’s long-term trend remains up. After bottoming at a low of $63.57 this past May, the spot-month contract rallied to a high of $95.03 during September. This was followed by a lower monthly close for October ($81.02) and what looks to be another lower monthly close at the end of November. If so, then this fits into my idea of a Benjamin Franklin Fish Similarity[ii] meaning the spot-month contract would be expected to close lower at the end of December as well. Applying the loosest version of Elliott Wave Theory puts the bottom of this wave, what I see as Wave 2, near $70.30.
From a seasonal point of view the spot-month WTI contract tends to drop 12% from the first weekly close of October (10-year index) through the third weekly close of December. This year’s market saw WTI post a first week of October close of $82.79, putting the downside target near $73.00. In other words, what we are seeing is a seasonal selloff within what could still be considered a long-term uptrend.
Is WTI crude oil bearish? I wouldn’t call it that, after all the spot spread is still showing the last vestiges of a backwardation, and in a storable commodity that means fundamentals are bullish. But there is no reason for investment traders to buy at this time, allowing them to shift their money to other markets where fundamentals are more bullish (e.g. soybean meal, almost anything in the softs sector, etc.). At some point noncommercial buying is expected to return to crude oil, possibly as it establishes its seasonal low before the end of the year. We’ll see what the spreads are telling us at the time.
[i] From Technical Analysis of the Futures Market by John J. Murphy, 1986 ed., page 2
[ii] The Benjamin Franklin Fish Similarity tells us, “Like guests and fish, markets start to stink after three days/weeks/months (whatever time frame is being studied) of moving against the trend”.
On the date of publication, Darin Newsom did not have (either directly or indirectly) positions in any of the securities mentioned in this article. All information and data in this article is solely for informational purposes. For more information please view the Barchart Disclosure Policy here.
