Fill Your Cars, Top Your Tanks
As we enter a new week and “things” are calming ever so slightly incrementally, crude oil is the story of the overnight as the front month, May, expires and is in total collapse. This is not what it seems on the surface. Yes, crude oil is down sharply again, but the 30% crash has more to do with structure of the commodity contract than a real crash. I need to choose my words carefully and not overwhelm you with lingo.
Crude oil is a commodity and its contracts to buy and sell expire every month. It’s designed that way for producers to be able to hedge their production as well as consumers of crude to be able to buy large quantities in the future. When commodity contracts expire and roll on to the next trading month, the price rarely picks up where the last one left off. Sometimes, it is higher and sometimes it is lower. For those of you with more advanced knowledge, we know this as contango and backwardation.
Anyway, the May contract for crude oil expires now. Rumor has it there is very little storage available. Think about all those market participants who held the May contract, hoping to find storage. Now, they are seemingly dumping those May contracts on the market because they cannot physically take delivery. There’s no room to store the oil anywhere.
May crude oil is trading at $8 a barrel. June is $23 and July is $28. August is $29 and September is $30. The farther out you go, the more expensive crude oil is as there is an expectation of much higher prices as the economy rebounds. Be very careful reading too much into the media hysteria that crude oil is going to $0 or even negative. While it certainly could happen today for structural reasons, that’s not where the real market is.
The backdrop for crude is so negative that it may actually be a positive. It is very possible that oil tries to hammer out a low this week. That’s one big opportunity to watch for. Remember, while we love low oil prices as consumers, too low prices hammers our economy even more as so many of the new jobs created since 2009 have been in the domestic energy industry. Oil under $40 is basically unprofitable, not to mention that hundreds of billions in high yield bonds have the risk of default. So, we really need oil that is not too high, but not too low. Goldilocks.
And with this headline collapse in oil, stocks are looking solidly red to begin the week. However, after Friday’s somewhat manufactured afternoon surge, I won’t be surprised to see some or all of that gain given back. Semis really lagged although it’s fair to say that they have been really leading. Banks surged and they have been behaving poorly after earnings season began.
All in all a pullback in the stock market probably has the highest likelihood right here. I think we have roughly 25K on the upside for for the Dow and 22,500 on the downside. I know. That range is widely enough to fly a parked Boeing 767 through. But that’s what happens when volatility is elevated.
Speaking of volatility, the Volatility Index or VIX which usually moves inversely or opposite to the S&P 500 did not make a new low on Friday as stocks soared. That is another reason why the market may be a little tired and in need of some giveback.