There is a substantial risk of loss in trading futures and options.

Past performance is not indicative of future results

On the radar:

That was humbling.

I’ve been in the commodity brokerage business since 2004. I’ve witnessed market behavior throughout the financial crisis, the US credit rating downgrade in 2011, and a few virus scares along the way. Yet, until now I hadn’t witnessed a commodity, particularly one as prevalent as crude oil, fall 40% in a matter of days. It was a truly humbling experience; one I hope I never have to live through again. To remove emotions, better described as trauma, we are looking to the charts in oil and gas to see what might lie ahead for these out of favor commodities.

Let’s start with seasonal tendencies. While OPEC headlines and coronavirus fears have been short term drivers there is some underlying seasonal support in both the oil and gas markets. Although it could be argued that travel will come to a halt this summer, it probably won’t. Further, summer will come regardless of the latest health scare. In other words, demand for fossil fuels will likely pick up to at minimum put a floor under pricing but at best give a boost. Oil generally finds a low in February and moves higher through May. Natural gas tends to find a seasonal low in March and is supported through mid-summer.

Natural gas speculators, on the other hand, are heavily net short. This is a trade that has worked well. The trend in gas has been persistently lower. However, with record net short positions the market is vulnerable to a sharp trend reversal at some point. Given the fact that we are bouncing off the 2016 lows, it could be sooner rather than later.

The greenback has been sleeping for years but volatility will eventually return. Perhaps the Fed’s surprise interest rate cuts will spur the unwinding of a carry trade that saw money flow into higher interest-bearing currencies such as the dollar. If so, the dollar index could finally break below 93.30 and find its way back to the mid-80.00s as was the case in 2018. Not coincidently, the price of oil traded in the $60.00s and $70.00s during that time.

The weekly chart of oil is a devastating reminder of how markets can sneak up on traders. Before it was clear whether the $42.00 area support would hold, the market gapped lower to test $26.00! While I had recognized this was a risk, I was not expecting it to occur and I certainly didn’t anticipate the way it did. Nonetheless, a retest of the 2016 lows was probably inevitable. Now that it is complete, we see the potential for one more round of stop running that could mean $23.00 or $24.00 but in the big picture, the pessimism has probably grown too large and the selling will likely dry up. The collapse in the dollar alone, should be good for a return to the low $40.00s. Previous support at $42.00 now becomes resistance. If coronavirus turns out to be temporary or the dollar continues to collapse, a break above $50.00 would put oil back into the previous trading range with the mid-$60.00s in play. In the past, when the RSI and William’s percent R fall into oversold territory, oil has generally managed to put big rallies together. This probably sounds nearly impossible, but if someone would have suggested in January oil would be in the $20.00s it would have been laughable.

The best word I can think of to describe the natural gas chart is, “pathetic”. Bids are short lived, and the bears are quick to jump on bounces. However, all good things must come to an end. Eventually, the natural gas bears will be enticed to cover their shorts; the sheer size of the position unwinding could be fierce. Like oil, the RSI and Williams %R indicators are nicely oversold. Trendline support as well as the 2016 low come in near $1.60. While stop running to $1.45 is possible prices are becoming extreme and vulnerable to sharp short squeezes.

In conclusion, this week’s options market volatility has been a gut-wrenching lesson in the simple fact that markets can remain irrational longer than most can remain solvent. Be careful out there.