Crude oil market commentary – March 2020

Here at TwoTwoFive we don’t trade; we teach people about trading. But as former traders we’re always interested in what markets are doing, and as you are probably aware, they’ve been doing a fair bit in recent weeks! Early in our courses we talk about the differences between trading using Fundamental analysis and Technical analysis, and the benefits of understanding both. How can this help us in the current market?

Let’s start with fundamentals; well we’re not sure it’s ever been so hard to analyse the fundamentals as it is right now, especially for a market like Oil. Two major events need to be considered, both almost unprecedented, certainly in the lifetime of current traders and investors: Covid-19 and the OPEC+ price war. How do you analyse the impact on demand of Covid-19, as it develops at different rates in different countries, and with such an unknown timeframe? Of course, there has been some excellent analysis published on this very subject, but let’s not underestimate how difficult this analysis is, how fluid the situation is, and how hard it is to trade using this analysis. And the supply picture is also very hard to pin down; how will OPEC and other big producers behave, will they fight over market-share, what is the implication of falling prices on their strategies? And, on the strategies of higher cost producers, for example in the USA and Canada?

Of course, one thing you can say about both these stories is that, at the moment at least, they are both unrelentingly bearish. Compare to 2014/2015 when Brent prices dropped by around 85$/barrel, losing almost 75% of their value. In our opinion the fundamental news at that time was less bearish than the news now, but there are important differences in the market too; most people agree oil prices were significantly over-valued in 2014, and as fundamentals turned bearish the price had to drop a long way to catch up. The market then did what it typically always does and fell too far… to a brief low of around 27$/barrel in Jan 2016 before rallying back towards 50$.

Now we’re starting to talk about Technical analysis. That low from early 2016 has been on many people’s minds as prices have dropped recently, not surprisingly as it was the stand-out low for almost 17 years. The market found some support near or just below 27$ in the last few weeks but has now traded significantly lower.

So, is Technical analysis the answer to understanding this market? As John J. Murphy says in his great book “Technical Analysis of the Futures Markets”; ‘Market action discounts everything’ i.e. we just need to look at what the price does to understand the market, because the price is moving as all the traders and investors out there react to the fundamentals.

However, we like to think of technical analysis as a way of understanding the emotion of the market and let’s face it markets are pretty emotional places right now! Back to Oil again and we have the two huge undeniably bearish news stories above; but also, traders and investors are probably working from home, maybe in isolation, maybe whilst also home-schooling their children; they are probably worried about family members, or themselves. In a way then, when you factor all the above in maybe it’s surprising the market has fallen further? The emotion of the market is negative, the market is falling, but maybe not as fast as it might have done given the situation.

Of course, the market could fall a lot further, maybe down to the 1999 lows around 10$? It could, but will it? We have absolutely no idea! Then again it could rise. If OPEC+ announced a production agreement, if there was a less negative headline around Covid-19 maybe the market could rally? It could but will it? Again, we have absolutely no idea! Having read this far, you’ll be delighted to know that the conclusion to this article is the market could go up or down! But let’s be honest, none of us know what the future holds, none of us know which way the market will go next. That’s why we need to understand both forms of analysis, Fundamental and Technical, and use them again to enhance our picture of what markets might do next.

Of course, we have already identified we think this is harder to do now than for a very long time, but that makes it even more important. As both situations develop, we will get a better picture of what’s happening to stocks, to supply and demand. The market itself will continue to tell us what traders and investors are thinking and doing.

As John Maynard Keynes said, “markets can remain irrational longer than you can remain solvent” and we should never forget that absolute gem of a quote because it is true. But markets actually strike us as fairly rational right now; they have reacted to these dramatic situations but arguably not over-reacted. Markets are however very volatile; the Crude Oil volatility index has more than quadrupled to a massive 150%, although that can partly be explained by the dramatic drop in prices; energy market volatility often increases as prices drop.

So, remember you now know where the market is going next; either up or down! That’s not very helpful but a basic understanding of trading, fundamentals and technical trading is. And if you are interested in volatility so is an understanding of options. Balancing risk and reward with such high volatility, the oil markets are currently for the brave and those with deep pockets.  Meanwhile we will keep enjoying watching the markets from a safe distance. Stay safe.

If you want to learn more consider trying one of our many online modules, maybe “Trading Fundamentals” or “An Introduction to Commodity Options”.

https://twotwofive.com/live-online-academy/

By Stefan Dixon