(This is a guest post from the author’s blog.)
The RBOB gasoline contract finished the week very strong and was the main driver for crude oil’s stellar bounce off the Euro zone downgrade which sparked a selloff earlier in the week. Crude oil rose to a three-week high and gasoline surged as a report showed the U.S. economy grew 3.2% in the first quarter on strong consumer and business spending.
Crude oil for June delivery closed at $86.15 a barrel on the New York Mercantile Exchange (NYMEX), the highest settlement price since April 6. Futures climbed 2.9% in April for a third straight monthly gain. Gasoline for May delivery also climbed 1.7% to $2.3963 a gallon, the highest settlement since Sept. 30, 2008.
Crude was also helped by the Fed FOMC decision to keep the statement language and associated monetary policy highly accommodative. This encouraged investors to pile into crude with a renewed risk appetite.
Contango & High Inventory
The latest weekly inventory report was positive regarding gasoline demand, but the rest of the EIA report was pretty bearish. Crude inventories increased by 1.9 million barrels, or half a per cent, to 357.8 million barrels, but is 3% below year-ago levels. (Chart 1)
U.S. gasoline consumption average over the past four weeks rose 3.1% year-over-year. Demand for the fuel was the highest since September. At the same time, U.S. refineries ran at 89% of total capacity on average, a jump of 3.1% from the prior week, while analysts expected capacity to drop to 85.72%.
Fundamentals will matter at some point, but that point will be reached only when we are swimming in stored inventory, and tanker storage becomes entirely cost prohibitive. However, we are still a long way off that point as the crude market is in Contango. And there are still plenty of tankers available to store oil that would otherwise be flooding the market.
High Open Interest Raises Overvalue Concern
Bloomberg reported that oil volume on last Friday on the NYMEX was 27% higher than the average of the past three months. Open interest was 1.41 million contracts, the highest since June 11, 2008.
Some analysts think the high level of open interest raises concerns about whether the market is overvalued relative to fundamentals and whether the upward price trend can continue.
Crude Now Has a High “P/E Ratio”
Indeed, crude is a very volatile commodity and a $2-swing is the norm these days. Factors affecting crude’s volatility are the Euro-USD currency cross, equities rise or fall, global economic news, and to some extent inventory levels, with the a rare case of geo-political news such as Iran injecting a short busting rip higher.
Nevertheless, crude is no longer strictly about the inventory levels, it has become an asset class in itself and trades more like a stock these days, rather than a commodity. That is, when people feel confident bout economic outlook, crude may have a high “P/E ratio” relative to the fundamentals; whereas a perception of uncertainty about the growth prospects globally will send its P/E ratio much lower.
Right now, investors feel positive about the global economy, so crude has a relatively high P/E compared to the market fundamentals including the inventory levels. But an event or series of events that create doubts, like overly aggressive financial regulation, trade-wars, currency and debt crisis, or a significant tightening by the Fed, could send crude oil much lower to a a significantly reduced P/E.
Crude oil now just sits below the 52-week high established on Apr. 6. With the renewed risk trade back on in crude, crude could test and break out of the $87.50 area this trading week, and establish a new closing high between $88 and $90 a barrel, depending upon if the Euro-zone actually reached agreement on a Greece bailout.
If it fails to blow past this newly established level, expect a pullback to the $85 level, which should provide some solid support. (Chart 2)
Make no mistake, Heating Oil and RBOB Gasoline have both broken out last week as well and will be going higher through the next couple of months, with the RBOB contract leading the way for the CL (crude) and HO (heating oil) contracts.
Bullish Through The Upward Bias
So overall, investors should remain bullish on crude oil for the next couple of months and take any significant sell-offs as entry points to establish long positions through the upward bias–the summer driving season.