Asia Open: Chaotic oil market trades into negative territory

Market Analysis / 7 Min Read
Stephen Innes / 21 Apr 2020

Has the perfect storm for the oil market has hit

Stock Markets  The falling oil price will have repercussions in its direct influence over energy stocks and weakness in EM markets who are price takes.
 
 Oil Markets,  WTI May 2020 settlement day, started as a bit of a novelty act as the bulk of the open interest had already moved to the June contract. Front-end oil prices did show clear signs of dislocation amid signs of very high supply.

Gold Markets:    US equities opened lower and stayed soft. This may have triggered safe-haven buying in gold. Both bond yields and the USD were little moved.

Asia FX: The chaotic overnight session in oil markets saw the USDMYR hit the top end of our weekly range

Stock Markets  

The perfect storm for the oil market has hit. We could merely be in the eye of the hurricane as the epicenters of its rage remain centered around demand devastation and crude oil oversupply. WTI May contract traded to USD-40.32/bbl, but its mostly the sharp plunge in demand that has seen saturation levels brim, forcing sellers to pay buyers to take May barrels.

Regardless of what OPEC does, there will be structural demand loss for oil due to less travel. At a minimum, oil prices will be the last asset class to recover from lockdown. End transport demand will only occur in the final stages of reopening when border crossing is allowed, and travel restrictions get lifted. People will then flock again to planes, trains, and automobiles.

US equities were weaker Monday, S&P500 closing down 1.8% after recovering somewhat after sharp losses at the open. Modest gains in Europe and a mixed session in Asia. US10Y treasury yields fell 4bps to 0.61%.

The falling oil price will have repercussions in its direct influence over energy stocks and weakness in EM markets who are price takes. But in terms of broad contagion, the oil shouldn't have a significant effect. I don't think the loss in equity futures is a direct consequence of the decline in oil. Energy accounts for just 2.77% of the S&P, whereas tech stocks account for 25%. 

Similar to yesterday, the early street call this morning is that risk has run too far, too quick. This rally has been fueled by very narrow leadership, mainly from 'stay-at-home' winners following widespread bearishness. With several "stay-at-home" names trading at or near YTD highs, the risk for a round of profit-taking might be on the cards ahead of SPX EPS reporting this week. (Goldman Sachs weekend note effect?) 

Still, we should look for periods where a violent short squeeze could play out again, especially if we get another stimulus package from Congress

Nevertheless, Tech was a bit shaky again on more profit-taking overnight. 

Sometimes I worry about my rose-tinted glasses view knowing that undoubtedly something will buckle perhaps on the credit or banking side. If I step back and take a logical look at trade equities from the long side vs. the most significant short on record (according to WSJ and Goldman Sachs calling Armageddon), stocks higher in a world of lower oil,

I can see why some people think I'm nuts. But there is madness in the logic. I trade the flows and willing to shift this view on a dime as I'm trying to survive profitably over the short term with a whack of profits in the bank to take advantage when the dollar weakens, and the long-term picture clears. The Trouble with pessimism is it's hard to make a buck in these markets today being negative. But that will change and trust me, so will my trade.

Besides, the EPS market is focusing on the world reopening, which should prove favorable for the equity market, but what's needed to push this market higher is a cure or a therapeutic as that's the prime recessionary input that needs reversing to increase global productivity.

Oil Markets

 
While the WTI May 2020 settlement day started as a bit of a novelty act as the bulk of the open interest had already moved to the June contract. Front-end oil prices did show clear signs of dislocation amid signs of very high supply.

After WTI May 2020, prices started to fall hard and eventually traded into negative territory. It piqued cross-asset trader interests, and the June contract has subsequently come under broad-based selling pressure, as the May contracts settlement plight has brought forward fears about limited storage capacity.

 The EIA said last week that US storage is about 55% full, and there have been daily additions close to 2mb/d in a previous couple of weeks.

Remaining global storage (ex-SPR) of around 1bn barrels will fill at 15mb/d during 2Q on UBS estimates, so it will potentially be full during 2Q unless there are additional cuts or an uptick in demand.

But even without the outsized focus on May WTI, there are many valid reasons to be worried about near-term prospects for oil.

One of the big reasons for the counterintuitive hefty long position in the Oil futures markets that needed to be rolled is the fact investors have been bottom searching throughout 2020 by flocking to the ETF market. Despite oil prices plunging through most of 2020, there has been approximately $11 bn buying year-to-date. This is an uncontended buy-record which has doubled the number of assets tracking the commodity in the space of only three months. Friday was the largest ever buy in day at $844 mn.

But the startling settlement fail could result in several shifts in risk management protocol. First, we could see some reallocation of assets out of futures into more stable Oil proxies. Second, calendar roll decisions could be brought forward, and third, there could be flat out liquidations. All three options could potentially put more pressure on oil prices over the next few weeks. My guess is these are happening, and the main reason why oil remained under pressure overnight as the storage saturation probabilities have not increased instead the curve has eased on a front contract to 12 months Brent basis 

It's far too early to call this a trade gone wrong with economic reopening happening around the world amid the increased likelihood of additional short-term interventions from G-20 and OPEC + producers. But this meltdown brought to bear a level of hedging unsophistication that more resembled pen and paper 1980's trading rather than the computer-modeled era of 2020

The reversion strategy is by no means dead in the grave.

Part of the reason the May WTI contract getting walloped is that it's physically deliverable in Cushing, Oklahoma, which is some 500 miles from the coast. With storage full up and limited pipeline capacity, there's only so much physical oil traders can do. However, it paints a worrying picture for US shale drillers. Even if the lockdown ends tomorrow, big chunks of the US economy have other pressing issues to face.

The other reason that seems to be lost in the headline barrage is the fact United States Oil Fund ETF can not take physical delivery, so they have to roll.

Gold 

US equities opened lower and stayed soft. This may have triggered safe-haven buying in gold. Both bond yields and the USD were little moved.

Oil prices usually have a positive correlation with gold. Higher Oil may be inflationary and can boost gold while the opposite can also be true, but in this environment, June WTI futures also fell more than USD4bbl to USD21bbl. The lack of near-term demand, as evidenced by plunging spot prices plus the economic dislocation of low oil, triggered enough investor angst to buoy gold. 
 
Currency markets
  
The Ringgit 

The chaotic overnight session in oil markets saw the USDMYR hit the top end of our weekly range right out of the gates. Should oil remain under pressure, which it's expected to, this could exert more downside risk to the Ringgit. 

The information is not to be construed as a recommendation; or an offer to buy or sell; or the solicitation of an offer to buy or sell any security, financial product, or instrument; or to participate in any trading strategy. Readers should seek their own advice. Reproduction or redistribution of this information is not permitted.

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