You may have seen me write before how “the curve always tells the truth” as part of my view going back several months of a growing divergence between physical and derivative commodity markets that has now been widely acknowledged.
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I often look at 2nd vs 3rd month because the front month roll and expiries can get very noisy and messy. Here I show you the 2nd minus 3rd month ($/bbl), back to June 2020 only because the super contango in spring 2020 makes more recent timespreads hard to see on a chart: 2/
The white line above shows you the current $1.40 backwardation between 2nd-3rd. As you can see we flipped to backwardation right at the start of last year (green), and despite the $10 two-day accident this week, the market is punishing storage and calling supply to come out.
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A better view is looking at the same timespread in % terms. Here the white horizontal line marks today’s 2nd/3rd month backwardation of 1.5%. With exception of Feb 11-Mar 31 and May 1-July 31 this year, the market has not been this tight since flipping backwardated in Jan2021: 4/
This chart shows you the % backwardation back to the flip in Jan2021, averaging 2% recently. 5/
Most who disagree with my “pounding the table” seem to suggest that demand destruction explains these selloffs — but this is not supported by the curve because if it were true, we would be collapsing like 1Q2020 into contango and requiring storage.
That is not happening.
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So with the above in mind, you can begin to understand why pros like @AndurandPierre have recently been pulling their hair out in public with a giant “WTF is going on”… 7/
…while others are even hinting at theories of US govt intervention to suppress paper markets ahead of midterms (the Saudis recently came close to saying this part out loud in their veiled threats to cut production as an offset to SPR releases).
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Simply put, speculators are having trouble accepting this divergence between the paper market which shows remarkable volatility AND downside bias versus an ever-tight physical market that continues to draw inventory out of storage.
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I wholeheartedly agree with @INArteCarloDoss that it is at junctures such as this that we want to be especially careful not to get sucked into conspiracy theories or emotions.
For the years spanning nearly all careers of today’s market participants, the oil market has been continuous, and despite occasional bursts of significant volatility, outcomes were bounded.
Covid’s super contango and negative WTI prices changed this regime forever.
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Oh yes…Remember those kooks who ranted in April 2020 about how letting prices go negative was an expediency that might make sense in the moment but might also have insane harmful, unforeseen consequences?
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Well voilà - I give you the paper/physical unhinged regime of 2022.
There is a straight line from April 2020 negative prices to the screwed up oil market topology we have today. So what does this all mean?
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I have written about this previously here… many of you liked this one and was probably my first thread to go truly viral:
We keep hearing the refrain of how the liquidity in all assets is terrible and it is not just a thin summer thing - it goes back all year and even longer.
The liquidity in commodity derivatives is *horrendous*.
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The fact that we are suddenly seeing $5+ daily swings in crude on the downside after many weeks of declining vol is giving many the impression that this is somehow indicative of a deflationary 2008 recession just around the corner.
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I think this view is wrong, and that this resurgence in vol is a very dangerous sign that the marketplace’s function of price discovery is having some trouble in coping with the crosswinds of positioning, rebalancing, and another bouts of forced degrossing…
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…and that the current equilibrium pricing is highly unstable.
The physical market has *not* loosened. The curve ALWAYS TELLS THE TRUTH. These reemerging microbursts of windshear are telltale signs of discontinuity that seeks to resolve a chaotic divergent condition.
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The physical market will always be the gravity that forces an eventual convergence with derivatives, because it is the collateral upon which the entire edifice of the market is built.
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Imho the oil market is coiled for a dramatic move higher and I have been aggressively positioning this week in expressing this view.
I make my share of bad calls and surely will eat plenty of crow for so visibly calling this one.
*Take NONE of this as financial advice.*
/FIN
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A few real gems from the past few weeks’ oil responses.
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There are many like this - flat and reasonably polite. I didn’t realize down 5-10% from basis constituted “shambles” but some people have tighter risk limits than others I supposed
Again “bust,” like “shambles,” seems somewhat strong, but one man’s correction is another man’s financial crisis.
Regardless of how all the wild speculation around the US Executive ends up in the coming days, weeks and months, the current uncertainty is growing my conviction rapidly in one way specifically:
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Oil powers the machine everywhere. The economic machine. The activity machine. The war machine. The Machine. It is the substrate of power and might.
The uncertainty splintering the minds of many in the market could end in up with “oil as the next gold,” in the following way.
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For almost two years we heard “but, but real rates are going up, how is gold going up??”
We now know why the divergence. Hindsight = 20/20.
Similarly, in 2024-25 the refrain could be “but, but US is flirting with recession and Asia is vulnerable — how is oil going up??”
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My buddy @kevinmuir wrote one of the best things I have read all year:
Rate hikes have been net stimulative as borrowers termed out lower while higher govt rates generate income accruing to debtholders with a tendency to buy financial assets vs spend, fueling mini-bubbles. Lower rates from a slower economy will have the opposite effect on stocks.
I have said ad nauseum how we are speaking Portuguese and don’t realize it in the EM-ification of USA. A key mechanism to turning Brazil into one of the highest gini coefficients in the world is precisely an elevated nominal/inflationary feedback loop environment which, taken to BZ’s extreme, has resulted in payroll loans and consumer credit at 30% *per month* while the rich would park in BZ sovereigns earning 20% nominal/10% real and send their money to swiss mountaintops while flying private. Modern day Gilded Age robber baron shit handed down from the era of sugar plantations but without the production of Carnegie steel and Rockefeller oil — just constant gini tightening.
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Because the economy became uncompetitive (protectionism, lack of education, horrendous waste and public corruption) and woefully inefficient, the feedback loop of fiscal creating money that the CB would try to stanch would further reallocate/siphon wealth in classic Austrian style from the working/poor classes to the politically well connected and rich.
This is the subtle link between Mises and Mosler and where MMT and Austrian have more in common than perhaps they would ever admit.
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Putting this here rather than behind the stack paywall and doing it before 6pm because I am seeing a lot of really shit takes on why this was a nothingburger since Iran didn’t hit anything major, “all bark no bite,” and so gold and especially oil should be faded.
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I think people who are thinking this way about oil in particular are scarred by 3 - THREE - successive physical dumps over the past 2 years and that is Martingale thinking gone awry.
1) Russia invaded, and Biden that summer cratered oil with a historic centimillion bbl sale.
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2) Oil tried to rally fall 2022 and Russia smoked positioning with a 40mm bbl crude dump in Nov-Dec22 followed by 40mm bbls diesel. Positioning took months to rinse.
3) 3Q22 rally into Oct 7th and Iran sold something like 80mm bbls of crude and naphtha on water. 4Q23 plunged.
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If inflation misses for March and maybe April before scorching later in 2Q as I expect, the Fed has cover to be dovish *which is a shitshow negative for the long end of the curve* as it reinforces the policy mistake made months ago.
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If it comes hot, then inflationists have confirmation and pour it on again and consensus longs freak TF out because inflecting growth AND inflation is literally kryptonite for bonds.
While everyone screws around with AI this week, this glorious year for macro continues unabated. Will try to drop a note on the Fed via the blog in my bio tomorrow, but meanwhile here is a rare drop from behind the wall/chat earlier for those who care about the BoJ and yen:
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JPY - just occurred to me maybe I have had this all wrong. I should have been listening to myself from early 2022 all along when I dropped the Velociraptor thread that many of you liked back when JPY was <125 on its way to 150.
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BOJ will slow walk this to 50bps next year. This still makes yen the ultimate carry trade. And weak jpy works for them in lieu of negative rates. It’s a form of easing.
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