Macro Dragon: Oil closes at -$37.63, -306% overnight.... & Dissecting Gold

Macro Dragon: WTI -37.63, -306% + Dissecting Gold

Top of Mind…

• Over the next two to perhaps three Macro Dragons, we are going to get a little deeper into gold. KVP will explain why being long gold, is one of those rare Prime Conviction trades… yet before that we will first look at a bear case for gold, then the bullish case & then a separate charts only piece – that will revisit price action during GFC & contrast it with what we have seen so far this year.

• On oil, Ole Hansen, the Dragon & the entire #SaxoStrats team have been banging the drums on this since Trump’s infamous tweets…  Ole “the Oil Baron”, granted was on the structural oil decline theme way before that.

• the May contracts had a closing price of -37.63. That’s not a typo… that’s a negative print for oil & a -306% move. If this does not prove that once & for all anything is possible in the markets, then nothing does – let that be a warning shot to those of you who still think UST cannot trade with negative yields… besides it being the norm across the Atlantic.

• Here was Ole’s pieces from o/n…  Crude oil collapse continues amid lack of storage

• KVP caught up with Ole briefly on this thing called a phone call (imagine that…) & checked in on when Ole felt we’d start to see a potential turn in demand. Ole – who has seen more rodeos than Texas & traded for many years in London (CTA firm)  – flagged a few things to keep in mind (this is KVP paraphrasing, so anything that’s wrong is his fault & anything that is right is Ole’s brilliance shining through again...)

• Situation is dynamic given that when & how we open up – focusing on the US – is really going to be unknown. There could be a head fake on oil rally on a sharper than anticipated opening up, but that does not mean in anyway that we are going back to normalization in the economy anytime soon. In only the last 4wks we have +21m unemployed, meaning they don’t have to drive to work & likely will be watching their spending very closely – i.e. its going to take a lot longer, likely minimum 2 quarters for oil demand to go anywhere close to what it was in Jan.

• Worth noting that this Thu alone, another +4.5m jobless claims are expected, which would take us to +25.5m in 5wks, that c. +15% of the 165m labor market in the US (both employed & those looking for work) – to give you context we were at c. 3.6% unemployment rate in Feb, a 50yr low. We have lost more jobs in the last 4wks, than were created since the 2008-2009 recession.  

• That has to have a structural deflationary big impact on the c. +14.7 trn of consumer spending that we got at the end of 2019. The last IEA report estimated a global demand drop of oil of -29mbd in Apr & -26mbd in May. To give you context US Shale, Saudi & Russia production is c. +10mbd each, for a total of +30mbd... & thats just from those three.... 

• This likely means, continue to expect the back end of the curve to break down to the front end. In the event of an eventual stabilization in the global economy & US, say tailwind of 3Q to 4Q (yet even 1Q 21 is possible), the front end will rise, whilst the back-end will likely stay put. This implies that shorting say the Dec or Nov WTI contracts there is less risk of the c. +40-50% squeeze that we experienced a few wks back. Folks can also look to play the spreads – which should be less volatile -  shorting the front end & buying the back. From a an options perspective, volatility is high, so obviously one needs to also assume its going to go higher if one is buying options (For context oil 3M implied volatility is c. 82, well south of the 127ish highs on Mar 18, yet also a spike from recent 60 lows on Apr 13.)

• There is a big gap in understanding on oil prices & future contracts, that is not just centered on the private speculative & investors side, but also hovering some institutionals traders & investors alike.

• Biggest example of this is on the oil etfs UCO & USO which are attracting humongous flows of capital & continue to collapse: UCO 1.35 -97%, USO 3.75 -11% (think that USO construction may have more backdated contracts than UCO & also does not employ the 2x leverage that UCO has on its benchmarks).  

• In a nutshell during ‘normal time’ (sounds like once upon a time fairy tale, prior to all the Fed/central bank printing presses & synthetic markets), the oil market tended to have backwardation – which generally means that prices are lower the further out you go on the horizon (curve starts from upper left & curves down to the lower right). However, given the Covid-19 shocks, markets collapse, production increases etc… the oil market is now in contango – prices are higher the further back out you go (curve moves upward to the upper right).

• The oil bulls will tell you that this is simply because the front end of the curve is wrong & demand will return, the bears will tell you – just wait for the domino effect… demand went it eventually comes will be a fraction of what the back end is expecting. So when a commodity curve is in contango (Coffee traders/investors anyone), it rewards those who can store it & penalizes everyone else.

• A bear, a bull & a dragon walk into the bar at the AG Inn…  As they are served whisky sours, the dwarf bartender explains that it just so happens that the last customer to drink in this very bar keeled over, yet before doing so… left their entire fortune to the owner of the AG Inn. Now having come into some money & being a one allocation kind of guy, the dwarf was thinking about investing it in gold. Would any of the three seasoned investors have a view on the merits of gold?

• We’ll cover the bear, bull & dragon views on gold over the course of the rest of the wk. Feel free to share any exceptional & well thought our arguments for both bearish & bullish skews on gold.

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On The Radar Today…

Flash PMIs (Thu), when + how do we reopen (May-Aug) themed week 17

• AU: RBA Mins plus Lowe Speaking, CB Leading Index

• NZ: Milk auction

• UK: Avg. Earnings, Unemployment Rate

• EZ: German ZEW, Euro-Zone ZEW

• US: Existing Home Sales

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