August 26, 2024
The Fed’s overt pro-growth commitment arrives just as “The Cruelest Week” for commodity futures trading comes to its end. Physical oil market balances tightened noticeably on Friday, well before Russia’s attack on Ukraine’s energy infrastructure today. We saw price-based evidence of that tightening pass directly from the cash markets into the futures. Today’s further advance in crude futures is also physically led. It is more fundamental than geopolitical.
The first chart below shows the progression of the Oct-24 NYM WTI crude oil price (CLV4) since the Commodity Condition Index (CCI) for medium sour crude picked up a meaningful slump in Chinese crude runs at the end of June. That signal presaged the subsequent decline in WTI prices from mid-July into last week. Physical market indications signal the risk reversal now underway probably has legs. Today’s intraday high for CLV4 as we write ($77.60) marks an increase of +$6.14 (+9%) since the intraday low on Aug 21 ($71.46). More important, the backwardation in the prompt V4X4 timespread has steepened to more than +$1.20 per bbl, a new high.
The second chart below maps the progression of investors’ risk perception in the Brent crude oil market over the past five months and situates it relative to the contemporaneous risk perception of commercial hedgers (both producers and consumers). The takeaway is: since mid-May, investors have been fixated on real but lower probability downside scenarios for price (outcomes with <10% chance of occurrence). OPEC+’s planned timetable for returning oil supply to market (announced in early June) and the downward momentum in oil prices over the past six weeks have reinforced investors’ negative priors about event risk and recession risk.
This focus on the rough rather than the fairway makes investors’ commodity books vulnerable to a growth-driven upside price surprise transmitting from the cash oil markets into the oil futures markets. This blind spot in turn raises the question of whether investors are too lightly positioned for the potential of rising oil prices to drive a pickup in value of energy-related equities.
For now, the CCIs for petroleum are still rebuilding (WTI = 10S, Brent = 9S, sour crude = 7D, gasoil = 7D). Commodity leadership is sequencing in the order we’d expect ahead of the likely September FOMC rate cut. Precious metals are first (gold = 21A, silver = 17A), followed by industrial metals (copper is now back to neutral at 15A from 10D a month ago), with the consumable energy commodities lagging.
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