Thursday, November 12, 2015

Relentless Selling in Crude

Crude oil never gave the counter trend trader an opportunity to reload on the short.  It is weaker than I thought.  We will be going to the 30s by December.  I would guess $38 is a floor, the low from August.  It is the weakest time of the year seasonally for crude oil, and the way it cannot lift at all when equities bounces, but always falls when equities falls is a bright flashing red light.

Usually with this weak crude oil you would be getting a strong bid in Treasuries, but that hasn't been happening either.  Perhaps after all the Fed speak today you will get the bond buyers coming back in, but fear of the rate hike will be around for the next few weeks.  I still want to buy but there is not much volatility, the market hasn't gone anywhere this week.

Stocks are gapping down again today.  It is probably a sell the rumor, buy the news thing going on with Yellen and company speaking today but just not that excited about buying the dip here.  It would be more interesting if we could get down towards 2040, but I am not holding my breath in anticipation.  Just a bad trading market, overall.


shzhning said...

Hello, I'm not a seasoned trader and knew little about the inverse correlation between bonds and crude oil. Is it a recent phenomenon or it has been going on for quite a while? Does it have any fundamental reasons? I used to believe bonds and stocks move in the opposite direction, but this has not been the case for the past few years now.

Anonymous said...

Let me give you most of what you need to know about how the market works in relation to economics.

Low interest rates = low denominator in the discounted cash flow and higher value of stocks since future forecast cashflows are divided by the current (or expected interest rate) to get the valuation.

Low interest rates = strong bond market. Strong bond market means strong stocks, but when stocks gets weak, investors move out of stocks and into bonds because bonds at least are supposed to return a guaranteed rate of investment and provide a coupon payment. No such guarantee with stocks when they are weak unless the stock pays dividends (such as utilities which are like the bonds of the stock market).

Low interest rates = weak foreign currency or dollar, since that currency doesn't generate a lot of interest payment for holding it. Such as money markets in that currency, bonds in that currency, etc. Weak foreign currency also inflates the price of commodities and imports that are priced in other foreign currencies and causes inflation.

Weak foreign currency for commodities which are priced in that currency (in our case crude oil which are otherwise pegged to the petrodollar system) results in a higher price for that commodity. If dollar is weak, the price of oil, gold, and everything else priced in dollars goes up.

If the price of commodities like oil goes up, that means interest rates are low which means price of bonds goes up, and the the dollar is weak.

Hence if oil goes up, then bonds go up.

However, in the last few years since the Fed has adopted Keynesian monetary economics including ZIRP and more radically quantitative easing, financial markets have become so dependent on the freeflow and abundancy of liquidity to prop financial asset prices that any threat to this abundancy immediately caused a negative effect.

Hence when bond prices get weak because of a sudden threat of an increase of interest rates, higher rates are supposed to make the currency get stronger (hence the strong dollar), and a strong dollar causes all commodities like oil priced in dollars to be weak.

Marketowl is putting the cart before the horse. He's thinking that lower oil prices signal either a lack of demand or oversupply causing deflationary forces which gives the Fed less of a reason to raise rates and hence lead to a stronger bond market.

But it's not as simple as that. The general trend is that threat of higher rates causes the dollar to become strong, stocks, bonds and commodities like oil become weak because it costs more to buy and borrow the currency those assets are priced in.

Anonymous said...

Wrong about the direction of the market dawg. Guy above must be like a finance economics professor. LOL

Market Owl said...

Stocks and bonds do NOT move in the opposite direction. They are more positively correlated than negatively correlated. The stock market and the bond market are both in the biggest bull market since 1982. They are positively correlated in the long run. In the short term, it goes either way, but the stock market usually likes a strong bond market because it makes financing debt cheaper. Only when the bond market is rallying because of a very weak economy do you get a negative correlation.

Also with QE, you have both stocks and bonds going up together because the QE is not because of a weak economy, but to cause asset inflation.