- Like a number of markets, WTI crude oil has seen increased volatility over the last number of weeks, sparking the discussion of if the market is broken.
- From a structural point of view, as of last Friday's close, both sides of the market (noncommercial and commercial) remain bullish.
- Additionally, if we apply historic filters to crude oil we see it hasn't changed as much as our initial eyeball test might tell us.
A trader I follow on the X-site previously known as Twitter raised an interesting discussion last Friday. He pointed out spot-month crude oil was down 12% in 6 days, and even looked back at WTI’s brief life below back in 2020. Of course this was followed by a rally to $130 in just under 2 years’ time. Along the way we’ve seen market “tinkering”[i], global pandemics, a private meeting of the Authoritarian Leaders Club in early February 2022[ii] followed immediately by Russia’s invasion of Ukraine, the US Administration acting fast on emergency releases from the Strategic Petroleum Reserve and slow on refilling those barrels, while OPEC+[iii] continues to extend production cuts. But is the market broken? Let’s look at its basis structure.
When I talk about structure I’m referring to how every market has two sides:
- Noncommercial: Long-term investment money, a variety of funds, algorithms, etc.
- Commercial: Those traders actively involved in the underlying cash market
The noncommercial side sets the trend, it’s money flow determining price direction over time, and the reason Newsom’s Market Rule #1 states: Don’t get crossways with the trend. If one stays in step with the money behind a market, one tends to not get run over. What were the trends of WTI crude oil (CLX23) at last Friday’s close (October 6)?
- Minor (Short-term): The spot-month contract completed a bullish spike reversal on its daily chart, coinciding with a bullish crossover by daily stochastics below the oversold level of 20%. This both signaled (stochastics) and confirmed (reversal pattern) the minor trend had turned up. But I’m not 100% convinced given spike reversals on daily charts are not the most reliable.
- Secondary (intermediate-term): Down. The spot-month contract fell to a new 4-week low below $85.02 last week. If the minor trend has indeed turned up, it would be considered Wave B (second wave) of the secondary 3-wave downtrend pattern meaning the previous high of $95.03 should hold for now.
- Major (Long-term): The market’s continuous monthly chart continues to show an uptrend. This was confirmed with a new 4-month high beyond $83.53 during August 2023.
- The latest CFTC Commitments of Traders report (legacy, futures only) showed noncommercial traders still holding a net-long futures position of roughly 349,600. While elevated, it remains a long way from the most recent peak of 537,400 contracts (week of March 9, 2021).
What about the commercial side? The easiest way to read if this group is bullish, bearish, or neutral is to look at the market’s forward curve. Here we see contracts have been in backwardation[iv] (inverted) since at least April 2021. We see something similar in Brent crude’s (QAZ23) forward curve meaning both global and US domestic oil fundamentals have been, are, and will continue to be bullish for the foreseeable future. As long as this is the case, the noncommercial side has a backstop for its net-long futures position.
Based on its structure, then, the case could be made WTI crude is actually working the way it should, including the occasional round of ramped up volatility. But what about happens if we apply some of the other filters I often talk about?
I recently had the opportunity to take part in a Barchart webinar talking about my market rules. Included in this was Number 3, naturally, that says, “Use filters to manage risk”. These filters include seasonality, volatility (usually implied), and price distribution[v]. What tends to happen is when volatility explodes, the use of price distribution goes away as price ranges are reset. The trader’s post brought this to mind given the $170 per barrel move by WTI between April 2020 and March 2022.
But what I sometimes see, given the transitory (inflationary) nature of commodities is that these price ranges tend to ebb and flow, eventually moving back to the previous range[vi]. Using the distribution range of weekly closes for the 10 years between 2010 and 2019, before the pandemic and the drop below $0, WTI spent a great deal of time between $57 and $87. Last Friday’s close of $82.79 was comfortably in that range, sitting in the upper 40% of weekly closes.
So here’s what we know about WTI crude oil: The market remains fundamentally bullish, prompting noncommercial traders to stay invested with long futures (and other tools). And while volatility gets amped up from time to time, like last week, the market has fallen back to its previous price range. This tells us that maybe WTI crude oil is not broken, though there is still time before the next US Presidential election.
[i] I edited myself to this word in place place of others that are likely more fitting.
[ii] Recall China’s President Xi and Russia’s Putin had a private meeting in Beijing, just before the Winter Olympics got under way.
[iii] A group that just so happens includes Russia.
[iv] Backwardation/inverse means nearby contracts are higher priced than deferred issues. This tells us commercial traders need supplies now to meet demand, paying more up front for the spot commodity.
[v] I look at the percent of time a market posts a weekly close at or above set price levels, giving me a range I can use to study if the market is overpriced or undervalued.
[vi] Unless we see a key fundamental change, e.g. the US Energy Policy Act of 2005 and corn. Or in other words, Newsom’s Market Rule #6: Fundamentals win in the end.
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.
