“Takes two to tango two to tango
Two to really get the feeling of romance
Let's do the tango do the tango do the dance of love.”
-Dean Martin
As we noted earlier this morning in our Morning Call with subscribers (if you don’t have access please let us know), two recent fundamental factors give us pause as it relates to the prices of oil. The first is the weakness of the Ruble over the last three days, and down 1.5% overnight. The Russian economy, absent perhaps Saudia Arabia, has the most leverage to the price of oil, so when her currency weakens it is worth noting as a potential leading indicator for the price of oil. The second is the continued weakness of the stock markets of the United Arab Emirates, while we understand there are non-oil issues at play here, core Middle Eastern stock markets were down another 5%+ overnight, which once again suggests there may be another culprit.
The futures markets also often give us signals about the future of the front month price of oil. One month ago the spread on January oil futures, from Janaury 2010 to January 2011, was ~$6.00. That spread has now widened to more than $9.00 in less than a month. In futures parlance, this is what the floor traders call, Doing The Contango. In instances where the futures curve is sloped upward, this is referred to as contango. It is a normal state given that there are carrying costs to store oil, or any commodity for a period of time, but when the futures curve exceeds the carrying costs, the market is sending a direct signal. In effect, the curve is signaling that in the short term, there is more than enough oil above ground, which is a bearish short term price signal.
We are also starting to see some posturing ahead of the 155th OPEC meeting in Angola on December 22nd. Saudia Arabia’s Oil Minister, Ali al-Naimi, said the following while speaking at a meeting of various Arab states:
“Everything is so good now, we don't have to think very hard….The market is stable right now, volatility is minimum and everybody is happy with the price. It is in the right range.”
The Saudis are either quite complacent at the moment, quite happy at the moment, or attempting to signal that they do not think there should be any change in production, which is perhaps in their best interest, but not the other participants. It is also interesting to note that five non-OPEC members have been invited to this meeting, including Mexico and Russia, who combine to produce close to 15% of the world’s oil.
We currently have no position in Oil, but do continue to have a bullish view in the TAIL, which is three years or less, based on supply and demand dynamics that favor a longer term tightening of supply. In the TRADE and TREND, less than three weeks and less than three months respectively, the data points outlined above give us pause as it relates to being bullish on price. In addition, as we’ve outlined in the chart below, we have started to see a marginal decoupling in the correlation between the U.S. dollar and oil, which has been the primary factor driving price this year.
While we aren’t ready to be short of oil, we do know that when oil is Doing The Contango, it is probably not the “dance of love” for the oil bulls.
Daryl G. Jones
Managing Director
